Shopping for insurance is a painful process, so the more convenient we can make the purchase process, the more customers should be willing to pay for the same level of coverage.

Increasing access to information was long believed to improve how we make decisions, but study results proved disappointing1. Research found that it was convenience, not information access, that truly impacted decision-making. For example, providing calorie information did not impact meal choice but convenience manipulations – known as nudges – had a strong effect2

People were more likely to choose lower-calorie meals when it was more convenient to do so. Similar studies have shown that retirement savings rates3 and organ donation rates4 increase when those choices are made more convenient by default.  Making a socially positive choice convenient makes nudges use decision errors that ordinarily hurt people to help them instead.

Currently, customers wishing to buy insurance incur substantial search costs and inconvenience. Even where insurance is entirely searched for and acquired through the internet, underwriters do not submit fixed (bindable) quotes until very late in the process. These search costs are estimated to be an astonishing 158% of the average auto insurance premium5. While searching for a perfect insurance contract, customers also incur non-search ‘psychological’ costs. These costs all act like a tax on the insurance eventually acquired. Because the customer, not the insurer, takes on these costs, they reduce the demand for insurance. 

Essentially, the insurance value to the customer must exceed the customer’s premium together with these additional convenience costs.

The Benefit of Technology

Technology provides customers with greater convenience: they no longer need to search for insurance policies themselves. A frictionless process for matching customers with insurance policies eliminates search costs, drives up customers’ valuations, and shifts the demand curve for insurance. As a result, the customers who previously had very low valuations are now willing to buy insurance.

By eliminating the search process and allowing the customer to acquire an insurance policy at the same time that they acquire the good or service, the insurer can maximize the difference between valuation and perceived cost, or the customer’s reservation value, due to (1) salience, and (2) loss aversion. Salience bias is a cognitive bias that predisposes individuals to focus on more prominent or emotionally striking items and ignore those that lack prominence, even when this difference is irrelevant by objective standards. At the point of purchase, the importance of a new good to the customer’s endowment is particularly salient, so they are more likely to pay to insure it than at any later point in the future. 

Loss aversion refers to a well-documented tendency in behavioral economics whereby individuals prefer avoiding losses to acquiring equivalent gains. At the point of purchase, the customer maximizes their valuation of the new product they just received and is more likely to overweight the risk of losing it. They would therefore be more open to offers to insure this good at or below their reservation price. This could have a higher impact in traditionally under-insured asset classes, such as flood insurance and health insurance6.

Making the process of acquiring insurance “at the moment” would benefit the customer and have two significant economic effects: (1) it expands the size of the total insurance market; and (2) it further mitigates the adverse selection problem by lowing the pooled risk born by the insurer and the premium paid by customers.  With lower-risk customers joining the pool, the average cost decreases further, driving the price lower.

Unlike the “switch-and-save” model, wherein the long run, everybody loses, making the process of acquiring insurance more convenient is a win-win: the customer gets coverage faster and at a lower price. Simultaneously, the insurer has access to a broader customer pool that exhibits lower risk characteristics.

Next time, we will take a look at practical approaches to increase the convenience of acquiring insurance coverage, i.e., Embedded Insurance.

Contributing Authors from Oxford University:
Jacqueline Dai, Laura Fritsch, James Hall, and Mungo Wilson

1. Choi, J.J., Laibson, D., Madrian, B.C. and Metrick, A., 2005. Saving for retirement on the path of least resistance. Rodney L White Center for Financial Research – Working Papers, 9.
2. Downs, J.S., Loewenstein, G. and Wisdom, J., 2009. Strategies for promoting healthier food choices. American Economic Review, 99(2), pp.159-64.
3. Madrian, B.C. and Shea, D.F., 2001. The power of suggestion: Inertia in 401 (k) participation and savings behavior. The Quarterly journal of economics, 116(4), pp.1149-1187.
4. Johnson, E.J. and Goldstein, D. (2003). Do Defaults Save Lives? Science, 302(5649), pp.1338–1339.
5. Honka, E., 2014. Quantifying search and switching costs in the US auto insurance industry. The RAND Journal of Economics, 45(4), pp.847-884.
6. Kunreuther, H.C., Pauly, M.V. and McMorrow, S., 2013. Insurance and behavioral economics: Improving decisions in the most misunderstood industry. Cambridge University Press.