Mental accounting, access motives, and overinsurance

People exercising mental accounting have an additional motive for buying insurance. They perceive a risk of having insufficient funds available to self-insure. In this way insurance protects the consumption value of the insured asset beyond the expenditure to acquire/replace it. This complements previous approaches based on probability weighting and loss aversion to explain the high profitability of warranties and an aversion toward deductibles. It helps to account for why the value of a warranty is found to be positively related to the value of the product and why there is seemingly contradictory empirical evidence on how household income affects demand for warranties. The adapted model rationalizes a strong aversion to deductibles, and explains the observed sensitivity of this aversion to the insurance context. Finally, it predicts a strong impact of how an insurer pays out benefits on the value and cost of insurance. This can explain both the evidence on strong deductible aversion for flood insurance and the lack of such evidence for long-term care insurance

Behavioral Economics and Insurance Law: The Importance of Equilibrium Analysis

Because choosing insurance requires consumers to assess risks and probabilities, the demand for insurance has proven to be fertile ground for identifying deviations from rational behavior. Consumers often shun the insurance against large losses that they rationally should want (e.g., floods); and they are attracted to insurance against small losses (extended warranties, low deductibles) that no rational individual should purchase. But the welfare consequences of behavioral anomalies in insurance are complex, because consumers’ irrational behavior takes place in a market profoundly shaped by informational asymmetries. Under some conditions, deviations from rational behavior may actually generate insurance market equilibria that produce greater welfare than would be achieved in a market in which all consumers are rational. We summarize the literature and discuss the legal and policy implications of this conclusion

Behavioral Economics and Insurance Law: The Importance of Equilibrium Analysis

Because choosing insurance requires consumers to assess risks and probabilities, the demand for insurance has proven to be fertile ground for identifying deviations from rational behavior. Consumers often shun the insurance against large losses that they rationally should want (e.g., floods); and they are attracted to insurance against small losses (extended warranties, low deductibles) that no rational individual should purchase. But the welfare consequences of behavioral anomalies in insurance are complex, because consumers’ irrational behavior takes place in a market profoundly shaped by informational asymmetries. Under some conditions, deviations from rational behavior may actually generate insurance market equilibria that produce greater welfare than would be achieved in a market in which all consumers are rational. We summarize the literature and discuss the legal and policy implications of this conclusion

Warranty service contracts design for deteriorating products with maintenance duration commitments

With the increasing diversification of customers’ demand and purchasing behaviors, more and more manufacturers have focused their attention on the warranty service contracts design. The maintenance duration of the sold product, which plays an important role in the normal production and operation process of the user, is frequently taken into consideration in warranty contracts. In this study, we design different warranty contracts with various combinations of maintenance duration and availability requirements. The manufacturer commits to compensate for each overdue repair or failing to satisfy the availability target. The customers’ choice behavior is described by the multinomial logit (MNL) model, and customers often form their own minimum acceptable levels (also referred to as reference points) of maintenance duration and availability when making purchasing decisions, which have an impact on the contract choice. The expected warranty servicing profit is maximized to determine the optimal price, maintenance duration and availability. Finally, the proposed warranty contracts are demonstrated by numerical examples. We find that the maintenance duration affects not only the warranty cost but also the customer choice, which further affects the optimal contract pricing and profits

The premium as informational cue in insurance decision-making

Often in insurance decision making, there are risk factors on which the insurer has an informational advantage over the consumer. But when the insurer sets and posts a premium for the consumer to consider, the consumer can potentially use the premium as an informational cue for the loss probability, and thereby to reduce the insurer’s informational advantage. We study, by means of a behavioral model, how consumers would use the premium as an informational cue in such contexts. The belief formation process in our model assumes that both prior knowledge and the premium (as a proportion of the compensation) might have an impact on the consumer’s estimate of the loss probability. Moreover, the premium impacts the estimate through an anchoring-and-adjustment process. The model potentially leads to violations of rational expectations, with which the consumer overestimates the loss probability beyond what could be inferred from the premium, given the premise that the insurer must seek to break even or earn an expected profit. Our model analysis moreover implies that the frequency of such violations is non-increasing as the premium increases. Lastly, the model implies a generally inverted-U relationship between insurance demand and the premium, so that the demand is upward sloping at low premium levels and downward sloping at high premium levels. A pilot field study and a laboratory experiment provide robust evidence for our model implications and calibrations for its parameters

Behavioral Biases in Marketing

Psychology and economics (the mixture of which is known as behavioral economics) are two fundamental disciplines underlying marketing. Various marketing studies document the non-rational behavior of consumers, even though behavioral biases might not always be consistently termed or formally described. In this review, we identify empirical research that studies behavioral biases in marketing. We summarize the key findings according to three classes of deviations (i.e., non-standard preferences, non-standard beliefs, and non-standard decision-making) and the marketing mix instruments (i.e., product, price, place, and promotion). We thereby introduce marketing researchers to the theoretical foundation of and terminology used in behavioral economics. For scholars from behavioral economics, we provide ready access to the rich empirical, applied marketing literature. We conclude with important managerial implications resulting from the behavioral biases of consumers, and we present avenues for future research