Research Handbooks in Law and Economics series
Edited by Daniel Schwarcz and Peter Siegelman
Chapter 1: Behavioral economics and insurance: Principles and solutions
It is easy for consumers to make mistakes in insurance markets, especially when deciding whether to purchase insurance against low-probability, high-consequence (LP-HC) events. Consumers have a hard time collecting and processing information to determine the likelihood and consequences of these risks, with which (by definition) they have had limited or no experience. Hence, people often rely on feelings and intuition rather than careful thought when it comes time to decide what coverage to purchase. On the supply side, insurance companies face the risk of experiencing large claims payments, only part of which can be spread or diversified away through the law of large numbers if losses are highly correlated. Decision makers in the insurance industry and those who regulate, litigate, and legislate about insurance are also likely to make mistakes for the same reasons that consumers do. They often rely on their intuition rather than undertaking deliberative thinking because they have limited information from past experience on which to base their decisions. In this chapter we take a realistic but optimistic view of the prospects for improving the functioning of insurance markets.