October 14, 2019
The Behavioral Science on Buying Insurance
by Hasan Meral
Insurance companies need to focus on the feelings and emotions of consumers and not just working on statistics.
Why do people buy insurance, when they could spend their money on dozens of other excellent products and services? A classical answer would be, “to be safe against risks.” Then, why do some people spend thousands of dollars on insurance products while others don’t spend a penny? Doesn’t everyone want to be safe against risks?
To find real answers, it is necessary to take a closer look at the motivations of people.
Deciding whether to purchase insurance is not easy. Consumers usually don’t get any financial benefit in return for the premium they pay. However, in addition to financial benefits, insurance products offer moral benefits such as peace of mind and a feeling of safety. So the benefit of insurance from the customer’s view can be formulated as (risk expectation x coverage) + (moral benefit).
Thus, the motivation of customers to buy insurance depends on two main indicators: risk expectation and risk sensitivity. Risk expectation determines the expected financial value of insurance. Risk sensitivity shows the concerns of customers, so it directly affects moral benefit.
Who Wants Pizza?
Being cautious is the main instinct behind insurance purchases. Of two consumers who face the same risks, the more cautious one is more likely to buy insurance. Exercising regularly to be safe against chronic illness resembles buying home insurance to be safe against fire, theft and earthquake. Preferring fast food instead of healthy food is like buying a great TV instead of auto insurance. Purchasing an insurance product is like dieting; costs arise immediately, but benefits are achieved later.
See also: Behavioral Economics Show Details Matter
Generally, competition among insurance companies is thought to depend on prices, brand awareness and customer service. In fact, competition is much broader. Purchasing decisions cross product categories; people buy home insurance or… shoes.
Insurance companies should develop strategies to convince more people to buy insurance, not those shoes.
Fans of Insurance
The key point is: People make risk assessments based on their personal experiences, not actuarial tables. Therefore, insurance companies need to focus on the feelings and emotions of consumers and not just working on statistics.
People exaggerate the likelihood of risk occurrence under certain circumstances, which increases their sensitivity of risk. People will be more likely to buy insurance even if all other factors are the same.
- High Loss Frequency: Consumer tend to demand insurance where loss frequency is high even if severity is not so great. A house fire is a disaster, but a car accident is more likely. This explains why automobile insurance is one of the biggest lines.
- Customers With Claim: Risk sensitivity increases cumulatively. If you faced a negative situation recently, you look at the world more pessimistically. It would be a good strategy to offer home insurance to customers who made auto insurance claims the previous month.
- Highlighted Risks: If a risk is highlighted in public, people exaggerate the possibility even if risk occurrence is not high. Theft news broadcast on TV for a week would increase people’s tendency to buy home insurance policy for a time.
- After Tragic Events: Right after tragic events like earthquake, flood and terror attacks, people think they will happen again soon. It makes no sense to buy insurance after an earthquake because, statistically, a new earthquake is not to be expected soon, but sales rise.
- Uncertainty and Fear: Important experiences like having a baby or suffering a heart attack make an impact on people’s view of life. There will be a significant increase in risk sensitivity. Therefore, it would be a good strategy to offer life insurance bundled with family health insurance to a customer who had a baby recently.
Homework for Insurers
On the behavioral approach side, there are some basic steps to follow to grow the whole insurance market;
- Being Micro: Insurance products are not only complex but also are too focused on macro risks. In fact, the daily risks of our lives are more micro and ordinary. Why are major risks like fire or flood pointed out in home insurance products rather than damage to electronic devices or accidental risks?
- Being Visible: Insurance companies have a natural advantage because they pay thousand of claims every single day to people and touch their lives. Creating positive stories from negative events can bring life to insurance products.
- Being Informative: Insurers should undertake the mission of “warning against risks,” in addition to providing financial coverage. The insurance company that interacts with customers regularly and improves their risk awareness would build brand trust.
- Being Protective: Getting share from competitors is becoming tougher everyday. Insurance companies are not only competing with new-generation insurtechs but also with technology, entertainment and consumer goods companies. The most rational and cost-effective strategy could be retaining the existing customer portfolio.
See also: Machine Learning – Art or Science?
New-generation economic theories based on behavioral science provide important insights about customers’ decision mechanisms. Many organizations, from e-commerce companies to government institutions, are profiting from the insights. For insurance companies, a good place to state would be understanding that customers are not robots who just want the most coverage at the cheapest price.
Thanks to Daniel Kahneman and Richard Thaler for inspiring this article with their behavioral economic theories.