WP 2015-13 The Methodologies of Behavioral Insurance: Introduction to the Special Issue

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Published in 2016 in The Journal of Risk and Insurance, Volume 83, Issue 1.

ABSTRACT: The generic insurance product involves an agent giving up a certain amount of money ex ante some risky event in the expectation of being given some money in the future if something unfortunate occurs. It is immediate that “behavioral economics” has something to say about the positive and normative evaluation of insurance from the perspective of the insured. Risk preferences play a role, and there is now a rich body of theory and empirical evidence that some agents behave differently than the standard Expected Utility Theory. Time preferences play a role, since the premium is typically paid prior to the stream of expected benefits in the future, and again there is a rich body of theory and empirical evidence that some agents deviate from the standard Exponential discounting model. Subjective beliefs play a role, since perceptions of loss probabilities need not be the same as actuarial assessments, nor need they be updated over time consistently with Bayes Rule. Trust plays a role, since there can be “fine print,” lawyers, and outright corruption in any contract, leading to non-performance risk. Finally, some have questioned if models of probabilities and time-dependent and state-dependent payment structures is sufficient to describe the insurance decision completely. Some have argued for an explanatory role for affective, or “emotional,” components in the decision framework for insurance demand.

These five “behavioral moving parts” combine to allow one to explain a wide range of possible behaviors, and the general scientific challenge is how to rigorously identify each of their roles. Doing so, in a structural manner, clearly matters for normative policy design. Do we need better products, better decisions about insurance products, or a healthy mix of both?

Some years ago we started an annual series of workshops on Behavioral Insurance and Risk Management, alternating between Munich (MRIC, the Munich Risk and Insurance Center, Ludwig-Maximilians-Universität) and Atlanta (CEAR, the Center for the Ecomomic Analysis of Risk, Georgia State University). This special issue of the Journal of Risk and Insurance reflects research in this vein.