New behavioral economics research by Stone Center Affiliated Scholar Emiliano Huet-Vaughn and his coauthors proposes a way to make choosing the right card easier.
More than one out of five U.S. adults is considered unbanked or underbanked, according to the most recent estimates from the Federal Reserve. Individuals who are unable to get a checking account often turn to prepaid cards — a market that has grown at an annual rate of more than 30 percent in the last decade, reaching an estimated $352 billion by 2020. More than a third of these cards are general-purpose reloadable cards, known as GPRs, which are disproportionately marketed to and used by individuals who have low incomes; who are young, female, divorced or separated; and who live in high-crime neighborhoods.
While there are some benefits to GPRs, they typically have high fees. These fees can include fees for each purchase, reloading, balance inquiries, customer service, and even inactivity. And these fees and other card features are often presented in ways that make choosing the “right” card — or the card that best matches a consumer’s own preferences — particularly difficult. “Unfortunately, the way that choices are presented in this marketplace often leads to outcomes with subpar consumer welfare consequences,” says Emiliano Huet-Vaughn, a Stone Center affiliated scholar and the coauthor of a recent study on GPRs. “On the other end of the income distribution, many very high-income individuals have access to financial specialists who help them manage their money. With this outsourcing to professionals, they are significantly immunized from making inferior, casual financial choices induced by a choice architecture ¾ the way that choices are presented ¾ set up for a firm’s and not a consumer’s benefit. This is an inequality on top of existing inequalities.”
To help buyers of GPRs make better choices, the Consumer Financial Protection Bureau (CFPB) in 2019 implemented rules that required financial institutions to provide specific disclosures in both short and long formats. The short-form disclosures drew on the principles of choice architecture: just as having too many choices among products can be overwhelming for consumers, so can an excess of attributes associated with a particular product — in the case of GPRs, fees and features — leading consumers to make a choice that isn’t optimal.
The introduction of the short-form disclosures provided a real-world way for researchers to evaluate potential interventions in the GPR market. The recent study by Huet-Vaughn — written with Jeffrey Carpenter, Peter Hans Matthews, Andrea Robbett, Dustin Beckett, and Julian Jamison, and published in March in The Review of Economics and Statistics — also used choice architecture to analyze ways of helping consumers to choose the card that best matches their individual preferences.
In the first stage of the study, the researchers assessed the risk and time-usage preferences of participants drawn from a standard student subject pool, as well as data on demographics, cognitive ability, and financial literacy. In the second stage, the participants performed a series of tasks for payment and were asked to select their preferred method of payment from a set of GPR card options. In this second stage, the participants viewed one of three randomly selected ways of presenting the cards’ fees and features: one that is similar to cards in the unregulated status quo GPR market; a second that reflects the CFPB short format, which was designed to present information in a tabular form that standardizes the reporting of product attributes and allows for quick comparisons of various cards; and a third design, developed by the researchers: a consolidated tabular format that, where possible, includes various fee calculations for consumers, thereby reducing the number of attributes to compare.
The GPR card options presented to participants in the second stage were individualized based on the researchers’ assessment of a participant’s individual preferences. In a novel feature of the study, these assessments were not simply assumed for a subject but were derived from the subject’s first round choices, giving greater credibly to researchers’ ability to understand whether an option was “better” or “worse,” based on the subject’s own past choices. “By allowing a participant to reveal their preferences through many prior choices, we could calibrate the value of a future option to them in a way that replaces paternalistic notions of what a ‘mistake’ is with an understanding of optimal and suboptimal choices from the decision maker’s own tastes,” Huet-Vaughn says.
The researchers found that consumers routinely choose incorrectly under the status quo. Some evidence showed that the second, CFPB-inspired design increased the likelihood of making the “best” choice among the GPR card options, while the researchers’ own design significantly reduced the selection of the “worst” GPR card. “The findings provide a clear rationale for regulation in the GPR market to both standardize reporting of product characteristics in some tabular fashion, and to reduce, or consolidate, the characteristics (features and options) presented when possible to reduce attribute overload,” says Huet-Vaughn, noting that this recommendation represents his own view and not the CFPB or his coauthors. “This is a way to keep consumers, particularly underbanked consumers, from unnecessarily spending money on fees. This rationale likely extends to other consumer finance products as well.”
Read the paper:
“Choice Architecture to Improve Financial Decision Making”