Regulating consumer finance: Do disclosures matter? The case of life insurance

In any market, including the market for financial products, we expect that consumers read and understand disclosures about products, weigh the costs and benefits, and make an informed choice regarding purchase. Financial firms, however, respond to disclosure requirements by showing customers large quantities of paper full of jargon. Disclosures become obfuscated, and product features, terms and conditions, hard to decipher. There is also an information overload. Even highly financially literate customers find it difficult to read and understand what is on offer. They make decisions that they often come to regret as product outcomes unfold. Firms claim that customers had signed off on having understood all terms and conditions, leaving little recourse to customers. 

In this context, a 2015 Ministry of Finance Committee set up to, 'Recommend Measures for Curbing Mis-selling and Rationalising Distribution Incentives in Financial Products'(also known as the Bose Committee) made several recommendations on improving product disclosures. Many regulators in India have continuously made changes to their disclosure regulations in order to improve consumer protection outcomes.

One would find it hard to argue that disclosures shouldn't be better designed. The devil is, however, in the details. How do we design effective disclosures? Even if disclosures are made simple, would consumers pay attention to them? Would they change behaviour because of the disclosures? How have customers reacted to changes in disclosure regulations? What have we learned about what kinds of disclosures would have the desired effect? What more do we need to understand? How does this shape our thinking about financial regulation? 

In a recent paper, Regulating consumer finance: Do disclosures matter? The case of life insurance, we use a sample-survey based experiment to understand the effect of simplified disclosures on an endowment insurance product.

We chose an endowment insurance product as this is a composite product that bundles insurance and investment, that often has a detrimental impact on potential returns which customers may not be aware of. Product brochures also showcase returns not on the amount invested, but on sum assured, making it difficult for customers to decode the real costs and benefits of the policy. This product has some of the most opaque disclosures as compared to other financial products in the market such as mutual funds, pension funds and small saving products such as the Public Provident Fund, or the National Savings Certificates.
 

Experimental design and results

We conducted household surveys in the cities of Mumbai and Delhi. The survey captured demographic and socio-economic details of the respondent such as age, gender, marital status, education, occupation, and household income. It also asked questions on attitudes to risk, retirement, basic questions on financial literacy, and prior purchase of insurance. 

We then offered customers a product brochure which consists of an investment of INR 50,000 a year for 5 years, with a tax break on income, and tax-free returns, INR 500,000 life insurance cover for 15 years, and regular money back across the life of the policy. 

We randomised survey respondents into one of four product advertisements (Treatments): 1) a baseline product with no additional disclosure, 2) disclosure of the actual rate of return on the product, 3) disclosure of the rate of return and a benchmark return of a similar product, namely the Public Provident Fund (PPF), and 4) the rate of return, benchmark return and product features of a more cost-effective competing term insurance product. 

We then asked respondents: did they think that the product was a "good" product? Would they consider purchasing this product? If not, why not?

We chose these disclosures because when a customer buys a financial product, she must look at several attributes. The most easily understood attribute is returns. But bench-marking those returns to an industry standard, comparing to an alternate investment and mapping real return are some of the key determinants to rational consumer choice. Investors, should ideally, look for and use all these metrics of information. Our treatments, therefore, progressively added information on these attributes to map the impact on potential buyers. We expected approval rates for the products to drop drastically for those in Treatment 4 over Treatment 1.

Our results can be summarised as follows:

1. The group which saw the disclosure related to the rate of return on the insurance product (Treatment 2), was 2.6 percentage points less likely to think that the product on offer was a 'good' product relative to the group that saw the baseline product with no additional disclosure.
   
2. Treatments which show additional data such as a comparison rate of return, or the price of a term insurance plan had no effect relative to Treatment 1, which had no additional disclosures.
   
3. Those with a higher score of financial literacy, and greater concerns about retirement react to the disclosure only in Treatment 2. Surprisingly, non-purchase of insurance in the past matters for effectiveness on product perception.
   
4. None of the treatments had an impact on the intention to purchase.
   

When respondents were given more than one piece of information, such as the rate of return plus benchmark, or the rate of return plus the benchmark plus the price of a pure risk product, they seem to have tuned out. Disclosures appear to work only when it is about a product feature customers know and understand. The concept of returns is something most people understand, and hence they are able to digest it quickly. Basic financial numeracy and retirement preparedness help towards recognising the returns disclosure but not much else.

Conclusion

The results of this experiment were contrary to our expectations that clear disclosures will change investor perception. The only disclosure that was read and understood by customers was that of returns. This suggests that for disclosures to have any effect, customers need to have a minimal understanding of the product features that are being disclosed. 

These results make us pause about the role of disclosures in consumer protection regulations in finance. It is tempting to require financial firms to keep improving their disclosures. But if disclosure regulations are not based on sound research of what really works, then we are imposing an unnecessary burden on financial firms, and ultimately consumers. 

What we need is a continuous and systematic process of design and evaluation of disclosures. This requires thinking on what makes a good disclosure, and whether the disclosure is having the desired effect. In parallel, we must think about other measures that can improve customer's ability to understand the various disclosures. For example, it would be insightful to evaluate if after some basic financial literacy training on what makes a good financial product, buyers are better able to understand disclosures, and make more informed choices. 

(This post is co-authored with Monika Halan. It first appeared on Ajay Shah's blog, 12 November, 2017)