Economic theory is rooted in the assumption that people generally behave rationally when they make financial decisions — but in reality, it seems we don’t.

Companies that strive to understand humans’ irrational quirks will be better positioned to sell their products and services, according to a behavioural economics expert who spoke at an insurance conference yesterday.

Evelyn Gosnell, of Irrational Labs, who specialises in the psychology of money, said: “We like to think of ourselves as rational, but we are heavily influenced — although in predictable ways.”

She said there was growing evidence that suggested that even when we have the information needed to make a rational financial decision, we are still likely to choose irrationally. Selling ideas that challenge the basis of economic theory gets a mixed response in the business world, she added.

“Some get the behavioural economics bug as soon as they hear about it,” Ms Gosnell said. “Others are slower to catch on. The many common assumptions out there are a strong force to work against.”

Irrational Labs is a non-profit organisation that applies behavioural ecomnomics — why we do what we do — to product, marketing and organisational design problems.

In her keynote presentation yesterday at the Bermuda International Life and Annuity Conference at the Fairmont Southampton, Ms Gosnell showed delegates some of the evidence that humans are just not logical when it comes to money.

She highlighted studies concluding that even though most people said they wanted financial security and could specify three things they could do to help achieve it, they tended to stop short of actually acting on this knowledge.

Some of our irrationality is driven by our tendency to think of money in relative rather than absolute terms, Ms Gosnell said.

She gave the example of seeing a pen in a store priced at $25, but then hearing that the same pen was available for $7 loss in a store five minutes’ walk away. Most people would take the walk and buy the cheaper pen, she said.

However, if someone was buying a $450 suit and was told they could purchase the identical item for $7 less at a nearby store, they would be less likely to make the effort — even though the $7 saving was the same in each case.

She then described “mental accounting” the process by which we categorise money into specific “buckets”. She gave the example of the city of Boston’s tax rebates. When the rebate was described as “bonus income”, the recipient was more than twice as likely to spend it as when it was described as “withheld income”.

The same process of mental accounting can happen, she said, when funds for the future are specifically labelled. For example, it would be harder to withdraw money from “Dave’s College Account” than it would be from “Savings”.

Our process of evaluation can also be easily influenced. She gave the example of a choice of annual subscription options for The Economist. When there was a straight choice between online access at $59 and print plus online at $125, most people plumped for online only. However, when a third option — the print edition only for $125 — was added, 84 per cent of people chose print plus online. Effectively the third option had indicated a value for the print edition in the readers’ minds and had made the print plus online deal look like a bargain.

The perception of value is often tied to effort. If it is apparent that you or someone else has put in a lot of effort into creating a product, then we are more likely to value it highly than if the effort involved is not so apparent — internet service, for example. Ms Gosnell highlighted one of the challenges for the life and annuities industry — that it is selling something whose benefits are far in the future. Our tendency is to discount, sometimes heavily, for time, she added.

It is among the reasons people struggle to save enough for retirement.

The Biltir conference was a one-day event which also featured sessions on the capital markets, cybersecurity in the insurance sector, predictive analytics and the state of the reinsurance market.