Research Handbook on the Economics of Insurance Law

Research Handbook on the Economics of Insurance Law

Research Handbooks in Law and Economics series

Edited by Daniel Schwarcz and Peter Siegelman

Insurance law and insurance economics each have long and distinguished scholarly histories, but participants in the two disciplines have not always communicated well across academic silos. The Handbook encourages more policy-relevant insurance economics scholarship and more economically sophisticated legal scholarship by bringing together original contributions from leading scholars in insurance law and insurance economics on a range of issues involving insurance law and regulation.

Chapter 1: Behavioral economics and insurance: Principles and solutions

Howard C. Kunreuther and Mark V. Pauly

Subjects: law - academic, commercial law, insurance law, law and economics

Extract

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.