July 26, 2013

Liability Management:Autopilot Refinancing

Jonathan ZinmanDartmouth College and

IPA’s U.S. Household Finance Initiative

Financial Products Innovation FundWorking Group Meeting

What’s This Talk About?

• Huge opportunity to add value by helping people manage their borrowing decisions

• Asset Management model for Liability Management• Take a segment of Liability Management:

“Personal Loan Shopper”• Focus on slice of that segment: “Autopilot Refis”

Debt is Where the Money Is

• Huge market for asset management– Brokers, financial advisers/planners, private bankers, etc.

• Yet debt is where the money is for most Americans• $13 trillion on household balance sheets– Many more people participate in debt market(s) than in,

e.g., stock market• Borrowing costs > asset yields– Higher stakes

Household Mismanage the Liability Side of Their Balance Sheets• (Or at least evidence suggests that they do)• Potential sources of “decision inefficiency”– Overspending– Misallocation

Credit cardsStudent loans

– Failure to take-up workouts (e.g., HAMP)– *Undershopping

Upfront contract choice (e.g., overpaying)When refinancing, or not

• Money on table => Money to be made

Is There Really Money to Be Made?

• Focus just on overpaying. Take a household that:– Has $10k in credit card debt and pays +500bp– Has $20k in student loans and pays +200bp– Has $20k in auto loans and pays +100bp– Has $200k in mortgage and pays +100bp

• This household is paying >$3,000 in excess interest per year– Annuity value of $15,000-$100,000, depending on discount

rate– Could get just a piece of this-- e.g., just auto loans– and be

viable

A Segment of Liability Management:Personal Loan Shopping

• There is a growing market for this already. Examples:

• Problems with existing products:– Limited personalization (key for risk-based pricing)– Limited coverage: a single site/app/service rarely credibly covers all

(low-cost) providers in the market– Biased coverage: nearly all business models are kickback-based– Limited/no coverage of refinancing

Where there are gaps, there are opportunities!

A Slice of Personal Loan Shopping:Autopilot Refinancing

Problem:

People don’t refinance (auto, mortgage, student loans) when they should• Sen. Gillibrand

seeks automatic refinancing of student loans at 4% rate (Examiner)

• Agarwal et al on mortgages

Why?

• Inattention post-origination• Procrastination (fed up by complexity of option value)

Solution:Find a better decision point -> at origination Put refis on autopilot• Allow borrower to set a refinancing rule at origination

– Like a limit order in asset management• Delegate mechanics to liability manager

– Manager shops and negotiates on borrower’s behalf– Manager handles paperwork

• Maybe even signing off under power-of-attorney

A Slice of Personal Loan Shopping:Autopilot Refinancing (Cont’d)

Making Autopilot Refis Work:Some Design Issues

(These issues apply to loan shopping more broadly…)

• Getting personalized data on consumers– How much?

• Getting accurate data on offers

• Accurately mapping consumer characteristics into offers

• Moving money

• Fiduciary standards

Making Autopilot Refis Work:What’s the Business Model?

• My premise: get borrowers to pay for it– Kickback model dominates, so differentiate– Wouldn’t transparent pricing be better?

BrandingRegulatory constraints/threatSignaling value proposition

• So how do we get there?– Issue for value-added services more generally

Making Autopilot Refis Work:Will borrowers pay? How?

“People won’t pay out-of-pocket for value-added financial services… they expect freebies”

– But people do pay out of pocket for credit report management, identity theft protection, tax prep, etc.

Pricing Models that have worked in other contexts• Upfront lump-sum

Natural for cash-out refinancing?Otherwise paid by credit card?

• Monthly subscriptionTeaser?

• Periodic “debt under management” fees

Pricing Autopilot Refis (and beyond):Unlocking borrower willingness-to-pay

Behavioral research offers some insights…• Willingness-to-pay depends a lot on framing, timing• E.g., on marketing and choice architecture– Content– Timing of offer– Ease of take-up (on-ramping)• Effectiveness can vary across contexts• So R&D needed to successfully apply these insights

to autopilot refis– To liability management more broadly– To financial product development even more broadly

Summing Up

• Huge missing market for liability management– Personal loan shopping is a big piece

• With autopilot refis a big piece of loan shopping

• Many technical challenges• Some design/behavioral challenges, with the most

important being business model– Unlocking willingness-to-pay

• My bet is that these challenges are solvable– Some will require R&D of the traditional variety– Others will require behavioral R&D, including the sort of piloting

and RCTs (AB-testing) that is supported by IPA’s Ford-funded work

Extra Slides Follow

Unlocking Consumer Willingness-to-Pay: Marketing Content

• Informative appealsHow to frame cost savings?How to signal quality/credibility?

• Emotional appealsHow to capture attention?How to counter procrastination?

• Behavioral evidence suggests that:– Both informative and emotional can be effective– Context and customer-particulars matter=> Optimizing content requires experimentation

Where do Consumers Go Wrong?(Product Design and Marketing)

What leads to undershopping, overspending?• Behavioral factors: self-control costs, limited attention,

price misperceptions• Confusion (financial illiteracy/innumeracy)• Disutility from personal financial management (distaste,

time costs)

How to solve for these pain points? R&D