Richard Thaler, a trained economist and practicing behavioral theorist, coined the term “endowment effect” to describe the human tendency to value something we own higher than we would value that same item if we didn’t own it.
He has a wealth of data from experiments he and his colleagues conducted to back up this assertion, and I see it in my practice as well. People will go to greater lengths to prevent a current policy from lapsing than they will to procure a new one. (Of course there are reasons other than the endowment effect that could account for this behavior).
The Nobel laureate Daniel Kahneman explained that giving up something we own feels like a loss, whereas not acquiring the same item does not have the same effect. Kahneman has proposed that this is because humans are generally loss-averse, but other researchers have attributed it to the mere ownership effect.
Some have said that it is our pride that causes us to value those things we own higher than if we didn’t own them. We bought them, and we’re pretty smart, so they must be valuable.
That certainly seems logical. But Thaler’s experiments showed that subjects who were given an item free of charge attached an unrealistic value to it. In one oft-quoted experiment, half the subjects were given a Cornell coffee mug and told they could take it home.
They were then asked at what price they would sell the mug to the group that didn’t receive one, and what price that group was willing to pay for one. On average, the group that received the mugs wouldn’t sell for less than $5.25 while the group that didn’t receive one wouldn’t pay more than $2.25.
So what does all of this have to do with life insurance? Well for one it deals with human behavior and that has to do with not only life insurance, but with purchases of any kind. Two, we do tend to value the insurance we currently own. But most importantly, we may not value that which we don’t own, which Thaler and his colleagues say is normal human behavior, but which could be disastrous if we truly need the life insurance.
Life insurance should be considered whenever we take on new financial responsibilities: a spouse, debt, children, etc. That’s not to say it should be bought at every one of those instances, but it should be considered to see if it makes sense. But a minority of the population actually does that.
Al Granum, a General Agent with Northwestern Mutual, kept detailed records of his agents’ statistics for over 50 years and he found that the overwhelming majority of first time life insurance buyers were between the ages of 25 and 35.
Those that hadn’t bought it by age 35 were much less likely to buy it in the future, whereas those who had bought it by that age were more likely to continue to buy it not only into their 40’s, but sometimes their 50s and beyond.
So to not value the latest technological gadget because we don’t yet own it is fine, but not valuing needed life insurance has the potential to wreak havoc on many lives.