September 23rd, 2008
Behavioral Economics:
Implications for an Aging
Population's Wealth & Health
Decisions
Anand S. Rao
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For more information contact:
Anand S. Rao
Partner
Anand.Rao@diamondconsultants.com
Mobile: 617.633.8354

Agenda |2
Agenda
What is Behavioral Economics (BE)?
What is the relevance of BE in Health/Wealth Decisions?
How can we model, simulate, and implement behavioral change?
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What is Behavioral Economics? |3
Reflexive & Reflective Systems of the Brain
REFLECTIVE SYSTEM REFLEXIVE SYSTEM
(Thinking) (Automatic)
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• People are Rational • People are Emotional
• Driven by self-interest • Driven by social influence
• Maximize utility • Averse to losses
• Have unbounded resources • Have bounded resources
Source: Diamond Analysis; Your Money and Your Brain by Jason Zweig

What is Behavioral Economics? |4
Rules of Thumb of our Reflexive System
NOT EXHAUSTIVE
MENTAL
STATUS QUO
ANCHORING
ACCOUNTING
BIAS
HOT vs COLD
ENDOWMENT RELATIVITY &
STATES
EFFECT CHOICE
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BANDWAGON LOSS HYPERBOLIC
EFFECT AVERSION DISCOUNTING
Source: Diamond Analysis; Nudge by Richard Thaler and Cass Sunstein; Predictably Irrational by Dan Ariely

What is Behavioral Economics? |5
Behavioral Economic Principles: Anchoring
ANCHORING
People start with a reference point and make (inappropriate) adjustments
while answering questions and making choices
1. How Happy are you? 1. How often are you dating?
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2. How often are you dating? 2. How Happy are you?
CORRELATION: 0.11 CORRELATION: 0.62
Source: Nudge by Richard Thaler and Cass Sunstein

What is Behavioral Economics? |6
Behavioral Economic Principles: Status Quo Bias
‘STATUS QUO’ BIAS & POWER OF DEFAULTS
People have a strong ‘status quo’ bias and often fail to take pro-active
action to change the default
Why is organ donation in Denmark below 5%, while in neighboring Belgium is
•
close to 100%?
% of Population that Participates in Organ Donation
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100%
90%
80%
Percentage
70%
60%
50%
40%
30%
20%
10%
0%
Country
Source: Nudge by Richard Thaler and Cass Sunstein

What is Behavioral Economics? |7
Behavioral Economic Principles: Mental Accounting
MENTAL ACCOUNTING
Mental accounting is an internal control mechanism of the ‘reflexive’ part
of the brain to compartmentalize complex decision-making
Scenario A Scenario B Scenario C
You have just won $30. You have just lost $30. You have just lost $30.
Now choose between Now choose between Now choose between
1. A 50% chance to 1. A 50% chance to 1. A 33% chance to
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gain $9 and 50% gain $9 and 50% gain $30 and 67%
chance to lose $9 chance to lose $9 chance to gain
nothing
2. No further gain or 2. No further gain or
loss loss 2. A sure $10
Choice 1: 70% Choice 1: 40% Choice 1: 60%
Choice 2: 30% Choice 2: 60% Choice 2: 40%
Source: Mental Accounting Matters by Richard Thaler in Journal of Behavioral Decision Making, 1999

What is Behavioral Economics? |8
Additional Behavioral Economic Principles
Rule of Thumb Description
People place a higher value on objects they own relative
Endowment Effect
to objects they do not
Offering customers excessive options to choose from can
result in purchase paralysis; People rarely choose
Relativity & Choice
something in absolute terms; they focus on the relative
value amongst options
People’s decisions under aroused or ‘hot’ states tend to be
Hot vs Cold States
significantly different from ‘cold’ calculated decisions
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People have a strong tendency to conform to the social
Bandwagon Effect
norms and often do things because others do
People prefer avoiding losses rather than acquiring gains.
Loss Aversion Studies suggest that losses are as much as twice as
psychologically powerful as gains
Consumption now and in the near future is preferred to
Hyperbolic
consumption into the farther future; The greater the
Discounting
uncertainty about this future the less the preference
Source: Diamond Analysis; Nudge by Richard Thaler and Cass Sunstein; Predictably Irrational by Dan Ariely

Relevance of BE in Health/Wealth Decisions |9
Behavioral policy interventions with respect to retirement savings is
showing early signs of 'nudging' consumers towards higher savings rate
Employee-Weighted Participation Rate BE Interventions
(Post-PPA)
1. Pension Protection Act (PPA) 2006
% of Employees 86%
• Automatic enrolment of employees in
401(K) with explicit opt-out instead of
45%
voluntary opt-in (Default)
• Automatic increase of the percentage
of salary directed to the plan (Pre-
commitment)
Hired Under Voluntary Hired Under Auto-Enrollment
Enrollment • Default investment into three broadly
diversified investments – balanced
Median Contribution Rate (Post-PPA)
funds, lifestyle funds, and managed
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% of Salary Contributed
accounts (Choice)
2. Save More Tomorrow (SMaRT)
5%
• Employees pre-commit to increase in
2.90% 2.60%
contributions well before their
0%
scheduled pay increases or bonus
payment (Pre-commitment, Loss
Participant-Weighted Employee-Weighted
Aversion)
Hired Under Voluntary Enrollment
• Employees can opt-out at any time
Hired Under Auto-Enrollment
(Default)
Source: Diamond Analysis, Measuring the Effectiveness of Automatic Enrollment, Vanguard Center for
Retirement Research

Relevance of BE in Health/Wealth Decisions | 10
In the absence of policy intervention Federal spending on healthcare
will rise from 16% of GDP in 2007 to 25% of GDP in 2025
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Relevance of BE in Health/Wealth Decisions | 11
Slightly over 4% of the Medicaid enrollees account for close to 50% of
the Medicaid expenditure
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Relevance of BE in Health/Wealth Decisions | 12
Simple behavioral interventions can influence what people eat and how
much they eat
OBESITY BE Interventions
1. Placing candies three feet away from
one’s desk reduced volume of
31%
chocolate consumption by 5 to 6
chocolates a day (Self-control)
15%
2. Subjects provided with a bowl of M&Ms
in 10 colors ate 77% more than people
given a bowl with only 7 colors
(Visceral effects)
3. Food stamp benefits raise food
<20 yrs 20-74 yrs
expenditure more than an equal
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amount in cash (Mental Accounting)
1. Obesity causes at least 300,000
excess deaths 4. Pre-ordered healthy-pack options
encouraged healthy eating by Food
2. Obesity in adults resulted in health
Stamp Beneficiaries in Connecticut and
care costs of $93 billion in 2002
North Carolina (Defaults)
3. Lifetime costs related to diabetes,
5. Having more unhealthy choices
heart disease, high cholesterol,
reduces the chances of health options
hypertension and stroke among
being selected – Salad, Hamburger,
obese are $10,000 more than the
Cake vs Salad and Hamburger (Choice
non-obese
Relativity)
Source: Could Behavioral Economics help improve Diet Quality for Nutrition Assistance Program participants,
USDA, Economic Research Service, Diamond Analysis

Relevance of BE in Health/Wealth Decisions | 13
Addressing more fundamental issues, such as medical malpractice tort
costs may require policy interventions by Government
BE Interventions
MEDICAL MALPRACTISE COSTS (in $Bn)
1. Unbundle healthcare
premiums to include cost of
30.3
29.4
28.2
medical malpractise
26.5
litigations (Accessibility
24.2
and Salience)
21.7
19.6
17.9
2. Health insurance companies
16.4
15.5
must be permitted to offer
14.1
13.3
12.5
11.5 plans with and without the
10.6
10.1
9.2
right to sue for negligence
8.5
7.6
7.3
6.9
6.8
6.7
(Choice)
5.8
4.8
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4.1
2.7
3.4
2.2
1.8
1.4
3. Make ‘waiving’ the right to
1.2
sue as the default and
retaining the right would
75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06
1. Medical malpractice tort costs have increased 229% cost more (Defaults)
between 1990 and 2006
4. Change the ‘right to sue’
2. Annual rate of increase is 11.1% since 1960 only for intentional or
compared to 8.2% for all other tort causes reckless wrongdoing and not
for negligence to reduce
3. Exposure to medical malpractice liability is around
malpractise premiums
5-9% of hospital expenditures
Source: Diamond Analysis; Insurance Information Institute; Nudge by Richard Thaler and Cass Sunstein

Agent-Oriented Behavioral Modeling | 14
Agent-oriented behavioral modeling and simulation offers a systematic
way of designing and implementing behavioral interventions
Agent-Oriented Behavioral Modeling & Simulation
Feedback Loop Feedback Loop
Behavioral
Behavioral
Economics Intervention - 1
Understand ‘reflexive’ BE
principles that determine
health and wealth
Behavioral
decisions Agent-Oriented
Intervention - 2
Behavioral Modeling &
Simulation
Modeling consumer
Market
beliefs, desires, and
Research
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behaviors to simulate
Understand consumer
different scenarios and
beliefs, aspirations,
evaluate impact of
attitudes, behaviors, and
consumer health/wealth
demographics
decisions on physical and
financial well-being
Predictive
Analytics
Use multiple data sources
(diagnostics, prescription, Behavioral
demographics) to predict
Intervention - n
risk groups and costs
Source: Diamond Analysis

Agent-Oriented Behavioral Modeling | 15
Diamond's market research on baby boomer health and wealth
attitudes and behaviors identified five significant clusters of consumers
Low Financial Confidence High Financial Confidence
High Health Consciousness High Health Consciousness
Aspirants
Moderates 31% 24%
(56yrs/ (62yrs/
$50K) $98K)
20%
Affluent
(57yrs/
Percent of
Sophisticates
$31K)
population
15%
Avg. Age/
(66yrs/
Avg. Income
$50K)
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Retired Settlers
Survivors
10%
(57yrs/
Low Financial Confidence High Financial Confidence
$24K)
Low Health Consciousness Low Health Consciousness
Source: Diamond Retirement Study, 2008

Agent-Oriented Behavioral Modeling | 16
The five segments are clearly differentiated in terms of their health consciousness
(e.g., regular exercise, health insurance cover, health risk during retirement)
Increasing Health Consciousness
Affluent
Retired Settlers
Survivors Moderates Aspirants Sophisticates
% who exercise at least 3 hours a week 49%
30%
29%
27%
15%
84%
% who strongly agree that they have adequate health insurance
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60%
50%
23%
17%
% who ranked physical health as most at risk during retirement 71%
63%
42% 39%
26%
Source: Diamond Retirement Study, 2008

Agent-Oriented Behavioral Modeling | 17
The five segments are also differentiated in terms of their financial confidence
(e.g., financial preparedness for retirement and healthcare issues, longevity risk)
Increasing Financial Confidence
Affluent
Survivors Aspirants Retired Settlers
Moderates
Sophisticates
82%
% confident of being financially prepared for retirement
57%
22%
3%
0%
76%
% confident of being financially prepared for healthcare issues that arise later in life
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43%
19%
10%
1%
% who ranked finances as most at risk during retirement
62%
51%
47%
31%
17%
Source: Diamond Retirement Study, 2008

Agent-Oriented Behavioral Modeling | 18
Findings from Behavioral Economics, Market Research, and Predictive Analytics
can be combined to model individuals as software agents
Agent-Oriented Modeling Example: Cardiovascular Disease
• Informational state • Demographic data
• Facts about the world • Beliefs about diet & exercise
• Beliefs about other • Impact of diet & exercise on cholesterol,
Beliefs agents stroke, etc.
• Current diet and exercise behaviors
• Social influence on beliefs
• Motivational state • Diet and exercise goals
• Committed desires are • Level of commitment or self-control to
Desire/
goals goals
Goals
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• Social influence on • Impact of social influence on goals
individual goals
• Deliberative state • Patterns of different diet and exercise
• Commitment to abstract patterns (e.g., regular vs sporadic)
Intentions sequence of goals or • Varying impact of diet and exercise on
specific actions cardiovascular events – stroke,
Myocardial infraction (MI), etc.
Behaviors of thousands of consumers can be modeled and simulated to evaluate impact of
behavioral interventions on individual well being as well as healthcare costs
Source: Diamond Analysis

Relevance of BE in Health/Wealth Decisions | 19
Simulating over 1,000 individuals as software agents helps determine
the impact of behavioral interventions on total cost and well being
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Source: Diamond Analysis; AnyLogic Simulation

Agenda | 20
Conclusions
• Behavioral Economics embodies principles that explain the
workings of the 'reflexive' brain and help in developing
interventions to change our behaviors
• Behavioral Economics principles are being successfully used to
change how people make decisions with respect to their health
and wealth
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• Combining predictive modeling and behavioral intervention already
practised within the healthcare sector, with agent-based
behavioral modeling offers a unique way to model, simulate, and
implement behavior changes