November 2015

Academia Meets Business―Case Study of a Startup Just Starting

By Thomas L. Totten


In a recent article published in The Independent Consultant, I wrote about my return to graduate school. My intention was to study a retirement problem. Little did I know how this experience would change my thinking about the problem and how it would influence my professional life. As a result of my return to school, we are now setting up a new company that will apply theoretical constructs to solve practical problems. In this article I describe the ideas that inspired the creation of a company.

The management of Nyhart, our parent company, an S-Corporation ESOP, is setting up an actuarial technology firm in Delaware. The S-Corp ESOP is owned by a qualified retirement plan which is exempt from income taxes. These savings could be invested to generate additional operating margin, but that’s an issue for a different article.

The process that we are following is grounded on the following academic research:

  • Clayton Christenson's book Disruptive Innovation;
  • Behavioral Finance as described by many authors. We have focused on the work done by Daniel Kahneman, Dan Ariely and Richard Thaler; and
  • Chip and Dan Heath's book, Made to Stick.

I’ll summarize key aspects of these theories and describe how they have influenced the creation of our enterprise.

Disruptive Innovation

The term is somewhat overused at the moment. Christenson studied how disruptive changes put companies out of business. The example that hit home was the steel industry. As a steel mill rat, growing up in northwest Indiana, home to the large coke ovens of US Steel, Bethlehem Steel, J&L Steel and Inland Steel, I assumed that the steel industry would live forever―my father and uncle spent more than 35 years in these mills. Clayton examined how the mini mills (think Nucor) destroyed most of the companies I mentioned. Clayton’s research showed that it wasn’t a new technology, but new applications of the existing technology that enabled the change. The mills also failed because they adhered to what many considered good management practices, such as exiting low margin businesses. It was an eye opener to see that businesses can fail by practicing state of the art management techniques.

To combat disruptive forces, Clayton formulates a plan that includes setting up separate entities that may compete directly against the company’s main product or service. It is only by challenging all internal systems that a company may cope with disruptive change. This is what we are doing at Nyhart. We are setting up a separate entity that will disrupt our current distribution model. The new entity has a different culture and balance sheet, but complete support from the CEO and the board of directors. There may be internal tensions between the entities, but we believe this is the path to the future.

Behavioral Finance

I find this topic fascinating. I believe that many actuaries could use behavioral finance in their fields. In 1965 Menachem Yaari wrote a paper that showed that rational risk averse consumers prefer annuities over other forms of payment streams in retirement when faced with an uncertain lifetime. As in any scientific field, you have to challenge assumptions and question whether people are truly rational decision makers.

The psychologist Daniel Kahneman and his co-author, Amos Tversky, developed the Prospect Theory after studying how people make economic decisions and in the process won the Nobel Prize in economics. I find particularly interesting two theoretical results: the first is that people overestimate low probability events and underestimate high probability events; the second is that people are willing to gamble losses, but prefer to capture certain gains.

As a pension actuary and much like Yaari, I thought rational people would tend to prefer annuities over lump sum payments. But since people overestimate the low probability of death, they may choose lump sum payments. It is well known that annuities are not easily sold, nor are they chosen in pension plans. These theories can be applied to help retirees make better choices. For example, I met with a group of my clients and shared hypothetical data related to retirement. I asked what would they choose at retirement, a lump sum payment or annuity? Unknown to them, one half of the group had additional information: the person was told to assume a 50 percent chance of living to age 85 once age 65 was reached. The sub-group with the additional information chose the annuity at twice the rate of the sub-group without it. The business we are creating will take advantage of Kahneman and Tvversky’s theory.


I never realized the business potential of psychology. But in my course of study I learned that management and marketing are simply the applications of psychology principles to employees or the masses, as the case might be. These were foreign concepts to me, a quantitatively trained person.

Chip (Stanford) and Dan (Duke) Heath are brothers and teach psychology. They formulated a simple plan to improve the effectiveness of marketing messages. Adherence to the principles described in their book “Made to Stick” increases the chances that people will understand and believe in your product.

Following these principles in the development of the website is difficult. However, the goal is the goal, and we hope to simplify a very complex topic.


The alpha version of the business tool will be released in the next few months. We will then use the methods described in the Lean Startup by Eric Reis to test our assumptions and improve our products and services. We’ll find out whether business theory meets practice. Regardless of the outcome, education is an end by itself.

Thomas L. Totten, FSA, Ph.D., is a consulting actuary. He can be contacted at