Younger Members’ Convention

2-3 December

The De Vere Daresbury Park Hotel, Warrington, Cheshire

The Psychology of Decision-Making

Sally Bridgeland

Hewitt Bacon & Woodrow

Psychology of decision-making

Rational is a subjective concept The key biases in human decision-making

And how these surprise those with a good understanding of probability and statistics

Expose your biases Use these results

Asking questions and contributing to meetings and conferences

Rational is a subjective concept

Maths Axioms and proofs Absolute truths One small mistake and the whole thing is wrong

Real life Rules are arbitrary and often cultural Most things relative rather than absolute Experiences and context shape what we see as rational

What’s the weather like today? How are you?

A simple question

Compare lines 1, 2 and 3 with Line A below. Which line is equal in length to Line A?  

 

A 1 2 3

The meaning of most likely

Linda is 31 years old, single, outspoken and very bright. She studied philosophy at university. As a student, she was deeply concerned about issues of discrimination and social justice, and also participated in antinuclear demonstrations. What is the most likely alternative:

Linda is an actuary; or Linda is an actuary and is active in the feminist

movement?

A simple question?

Compare lines 1, 2 and 3 with Line A below. Which line is equal in length to Line A?  

 

A 1 2 3

A less simple question

Suppose each of the cards below has a number on one side and a letter on the other and someone tells you: "If a card has a vowel on one side, then it has an even number on the other side". Which of the cards would you need to turn over in order to decide whether the person is lying?

E K

4 7

Answer: Do you suffer from confirmation bias?

The correct answer is E and 7 The rule being tested "If vowel then even number" can be

falsified by finding an instance of "If vowel then odd number", so the only cards capable of disconfirming the rule are those with vowels and odd numbers. The others are not relevant.

Most people choose E and 4, or E, reflecting what's known as a "confirmation bias".

People tend to look for supporting evidence and as a result are vulnerable to self-fulfilling prophesies. Scientists trained to disprove hypotheses may find this behaviour irrational.

Attribution

Suppose you performed well on a variety of tests over a range of occasions, but other people taking the same tests did not do very well. What would you conclude? (Pick the one answer that comes closest to your view).

Explanation A: The tests were probably easy Explanation B: The other people were probably low in ability Explanation C: I am either good at taking tests or must have

known the material well

Interpretation

Suppose a study of 250 neurology patients finds the following frequencies of dizziness and brain tumours:

BRAIN TUMOR  Present Absent

 Present 160 40

DizzinessAbsent 40 10

According to the data in the table, is dizziness associated with brain tumours?

Yes/No/Don’t know

Another question

When did I qualify? 3 years ago 5 years ago 9 years ago 13 years ago

How confident are you that you are right? Why might you be wrong? How confident are you now that you are right?

Some biases

Reference points and framing Social influences and group dynamics

A reference point

“The target audience is anyone who has qualified in the last five years …The majority of the programme will be presented by people like you …”

When did I qualify? 3 years ago 5 years ago 9 years ago 13 years ago

How confident are you that you are right? What reference points were you using before? Why might you be wrong? How confident are you now that you are right?

Reference points and framing

Primacy effect Halo words Surveys Leading questions

Primacy

John is envious, stubborn, critical, impulsive, industrious and intelligent. In general, how emotional do you think John is? (pick one number)

 Not emotional at all 1 2 3 4 5 6 7 8 9 Extremely emotional

Halo words

Jim is intelligent, skilful, industrious, warm, determined, practical and cautious. Please pick the other traits you think Jim is most likely to have from the following pairs:

Generous ─ Ungenerous

Unhappy ─ Happy

Irritable ─ Good-natured

Humorous ─ Humourless

Surveys

What do you think is the most important problem facing this country today?

 

The most important problem is:

_________________________________

Leading questions

Can’t say no? Easier to say yes than no The habit of saying yes

Avoid extremes Middle options Order to create reference points

Group dynamics

Persuasion Provocation Consistent disagreement Seniority and other social influences

Groupthink

Compare lines 1, 2 and 3 with Line A below. Which line is equal in length to Line A?  

 

A 1 2 3

Now you try

Two questions On your own

Gather responses blind

Two groups Debate

Gather responses again Discuss process

Horsetrading

A man bought a horse for £60 and sold it for £70. Then he bought it back for £80 and again sold it for £90. How much money did he make in the horse business?

 

The man ended up with a final profit of £ _______

PS If you were thinking of allowing for interest, don’t bother!

The law of small numbers

The mean IQ of the population of 14 year-olds in a city is known to be 100. You have selected a random sample of 50 children aged 14 for a study of educational achievements. The first child tested has an IQ of 150. What do you expect the mean IQ to be for the whole sample?

ANSWER: _____

Day to day application

Client advice Should I sell those equities?

One-to-one chats How am I doing?

Meetings Has anyone made a decision yet?

Conference debates Rational or emotional?

How do you use reference points and framing?

Presenting an argument Eliciting responses Provoking debate Asking for feedback

Non-actuarial assumptions

Who are you talking to? What are their reference points? What do they want to achieve?

What do you want to achieve? How far apart are you? Is there common ground?

Test your assumptions Establish existing reference points

Introduce new reference points Classic negotiation

With added reference points and framing

Parting thoughts

You will need to challenge other people’s biases to bring them round to your point of view

But when you do so, remember that All actuaries are irrational and biased too - so be

aware of your own biases

Asking for feedback

Where did I use reference points and framing in this presentation?

Prof K Warwick’s reference point technique

Further reading

Most of the questions in this presentation have been adapted from the Reader Survey in:

“The psychology of judgment and decision-making” by Scott Plous, published by McGraw-Hill in 1993

Behavioural finance applies and develops these ideas to financial decision-making. Try:

“Beyond Greed and Fear” by Hersh Shefrin, published by Harvard Business Press in 2000

“The Winner’s Curse” by Richard Thaler, published by Russell Sage Foundation

Please Note

This presentation is not intended to constitute investment advice or to be a full consideration of the issues raised.

Appropriate advice should be obtained before taking any specific action.

Hewitt Bacon & Woodrow Limited is a member of the General Insurance Standards Council and is an Appointed Representative of Hewitt Associates Limited, which is regulated by the FSA.

© Hewitt Bacon & Woodrow 2002