Insurance and Behavioral Economics: Improving Decisions in the Most Misunderstood Industry

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Cambridge University Press, Jan 28, 2013 - Business & Economics - 329 pages
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Insurance is an extraordinarily useful tool to manage risk. When it works as intended, it provides financial protection to individuals and a profitable business model for insurance firms and their investors. But it is broadly misunderstood by consumers, regulators, and insurance executives. This book looks at the behavior of individuals at risk, insurance industry decision makers, and policy makers at the local, state, and federal level involved in the selling, buying, and regulating of insurance. It compares their actions to those predicted by benchmark models of choice derived from classical economic theory. When actual choices stray from predictions, the behavior is considered to be anomalous. With considerable sums of money at stake, both in consumer premiums and insurance company payouts, it is important to understand the reasons for anomalous behavior. Howard Kunreuther, Mark Pauly, and Stacey McMorrow examine these anomalies through the lens of behavioral economics, which takes into account emotions, biases, and simplified decision rules. The authors then consider if and how such behavioral anomalies could be modified to improve individual and social welfare. This book is neither a defense of the insurance industry nor an attack on it. Neither is it a consumer guide to purchasing insurance, although the authors believe that consumers will benefit from the insights it contains. Rather, this book describes situations in which both public policy and the insurance industry's collective posture need to change. This may require incentives, rules, and institutions to help reduce both inefficient and anomalous behavior, thereby encouraging behavior that will improve individual and social welfare.
 

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Insurance is a ticklish concept and therefore its practice bears significant behavioral aspects both from the demand as well as supply sides. The contingent and distant nature of benefits makes insurance distinctive from all other financial services. All the problems confronting the insurance industry like low penetration, lack of credibility, adverse selection, moral hazard, mis-selling, unfair pricing and so on point out to some or the other behavioural aspect of buyers and sellers of insurance, in some way or the other.
This book provides an excellent analysis of these behavioural aspects that makes insurance the most misunderstood industry today. Based on real life examples, it reveals the anomalies in the behaviour of consumers and insurers that demonstrate a clear departure from their respective benchmark behaviours as per the classical theories of economics.
On the demand side, the book brings out instances of behaviour of insurance consumers that is anomalous top the benchmark models of expected utility. What are the motivations to buy insurance, apart from those triggered by the expected utility theory, why do people prefer savings linked products over pure risk products, why many prefer ex-post risk financing over ex-ante mechanisms like insurance despite the former being costlier are just some of the many critical questions this book answers through a succinct analysis of available research and real life examples.
The insurers’ tendencies to stop offering coverage or to upwardly revise premiums following a catastrophe or to offer products that apparently do not carry a high client value have also been analysed thoroughly. It also tacitly brings out why most insurers do not invest in consumer education. How do the actions of policymakers and regulators influence anomalous behaviour of consumers and insurers has also been discussed in detail.
The book goes on to lay down principles and prescriptions for insurers, regulators and policymakers that can address some of the behavioural anomalies keeping in mind the constraints of democratic governance and free market economic policies. Perhaps these prescriptions could have been more precise and could also have included aspects of consumer education and protection. But nevertheless they do provide many meaningful insights. The role that can be played by public sector in addressing the anomalies is also laid down well.
Though the book has been written in the context of mainstream US insurance market, the insights can definitely be juxtaposed to other geographic and demographic market segments. The analysis offered by the book can serve as strong basis for formulation of strategy and further meaningful research on the questions indicated earlier. An excellent read for anybody engaged in the insurance industry.
 

Contents

10
54
RealWorld Complications
69
Why People Do or Do Not Demand Insurance
95
Demand Anomalies
113
Descriptive Models of Insurance Supply
145
Anomalies on the Supply Side
162
Strategies for Dealing with InsuranceRelated Anomalies
208
Innovations in Insurance Markets through Multiyear
228
Conclusions A Framework for Prescriptive
267
Notes
281
Glossary
289
Bibliography
295
51
297
Author Index
309
113
313
185
321

Publicly Provided Social Insurance
244
11
246

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About the author (2013)

Howard Kunreuther is the James G. Dinan Professor of Decision Sciences and Business and Public Policy at the Wharton School, University of Pennsylvania and co-director of the Wharton Risk Management and Decision Processes Center. He has a long-standing interest in ways that society can better manage low-probability, high-consequence events. Dr Kunreuther is a member of the World Economic Forum's Global Agenda Council on Insurance and Asset Management for 2011-12 and in 2009-10 served as co-chair of the Forum's Global Agenda Council on Leadership and Innovation for Reducing Risks from Natural Disasters. He is a Fellow of the American Association for the Advancement of Science and a Distinguished Fellow of the Society for Risk Analysis, which honored him with a Distinguished Achievement Award in 2001. Dr Kunreuther also received the 2015 Shin Research Excellence Award from the Geneva Association and the International Insurance Society (IIS), in recognition of his work on the role of public-private partnerships in mitigating and managing risks.

Mark Pauly is the Bendheim Professor in the Department of Health Care Management at the Wharton School of the University of Pennsylvania. One of the leading health economists of the United States, he is a former commissioner on the Physician Payment Review Commission and is a co-editor-in-chief of the International Journal of Health Care Finance and Economics and an associate editor of the Journal of Risk and Uncertainty. Professor Pauly has served on Institute of Medicine panels on public accountability for health insurers under Medicare and on improving the financing of vaccines. He is a former member of the advisory committee to the Agency for Health Care Research and Quality and the Medicare Technical Advisory Panel.

Stacey McMorrow is a research associate in the Health Policy Center at the Urban Institute, Washington, DC. She is currently leading a study of the effects of increased federal funding for community health centers on access to care for low-income individuals and has analyzed the potential impacts of the Affordable Care Act on small employers, individuals and families. Dr McMorrow's PhD dissertation at the University of Pennsylvania explored the market-level effects of health insurance, specifically examining the impact of a large uninsured population on the availability of specialized hospital services as well as on utilization and outcomes for Medicare beneficiaries.

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