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

by Howard C. Kunreuther, Mark V. Pauly, Stacey McMorrow

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.

Genres: Economics

329 pages, Paperback

First published September 29, 2012

About the author

Howard C. Kunreuther (November 14, 1938 – August 1, 2023) was an American economist.

Reviews

[Suhrob · Rating 4 out of 5]

A pretty good overview of both "classical" (rational actor model), and behavioral approaches to the economics of insurance. Discussed are both the demand and supply sides.

Maybe two words of caution:
1. the book is quite academic and relatively technical - this is not a popular level introduction, but a material for undergrads and practitioners. The hurdle is not so much its technical level, but just a dry, academic style and high level of detail.

2. It is 100% US focused so for European audience the most concrete examples don't really apply. Of course the principles still work.

[Patrdr · Rating 4 out of 5]

This is not for entertainment, obviously, but it is an interesting and well-written, well organized account of the economics of the insurance industry. Actually I did find much of it entertaining in the sense that it was stimulating.
As the title suggests it draws on the recent surge of interest in behavioural economics which investigates ways in which the behaviour of individuals and firms does not fit in the standard model of rational behaviour. The authors ask whether apparent anomalous behaviour does or does not fit into the standard model. And, if there are anomalies, is a public policy intervention called for?
The book concludes with considerations for public policy and it is evident that many of the problems of the insurance industry arise from the regulatory process and the political dynamics that shape it.
I read this to educate myself and it served that purpose well. There were two subjects that have been arisen in my own experience of the industry, as a policy adviser, that I was interested in that were not addressed. The first is the role of fraud in the industry. Is insurance a uniquely favourable target for organized fraud? And, if so what can be done about it? Secondly, critics of the industry often point to the investment earnings from the pool of investible funds generated by premiums and, after episodes of low returns, charge the industry with gouging in order to make up for investment losses. Given the clarity of the authors' analysis, I would love to have seen them address these issues.

[Tony Canas · Rating 5 out of 5]

This rather academic book is an excellent read for anyone who works in the insurance industry and even for those who simply have an interest in better understanding how insurance works. It compares and contrasts consumer and insurer behavior against that predicted by classical economics (perfectly rational) and other psychological theories of behavior. It calls out both groups (and legislators) on where they behave sub optimally and suggests way to improve the outcomes of the insurance game. This is a serious and well thought out explanation of the industry through and through.