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10 - Design Principles for Insurance

Published online by Cambridge University Press:  05 February 2013

Howard C. Kunreuther
Affiliation:
University of Pennsylvania
Mark V. Pauly
Affiliation:
University of Pennsylvania
Stacey McMorrow
Affiliation:
The Urban Institute
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Summary

We have seen that both buyer and seller behavior in a number of insurance markets is sometimes anomalous when judged by the two benchmark models (expected utility and expected profit maximization). Although buyers and sellers have managed to create and use insurance markets to provide sufficient protection against many of the most important threats to wealth, coverage is limited for some types of risks where the losses can be significant, such as earthquake risk.

Some insurance prices in the market are high relative to the expected loss, such as rental car or renters’ insurance. At the other extreme, buyers sometimes purchase coverage against events that have low financial consequences, such as the failure of an appliance, where the expected loss is considerably less than the price of insurance. Sometimes they fail to buy coverage against a catastrophic event, even at very favorable premiums. When such anomalous behavior occurs, what, if anything, should be done to correct it? Are there government regulations, subsidies, or other actions that might be appropriate? What role can insurers themselves play in the process?

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Insurance and Behavioral Economics
Improving Decisions in the Most Misunderstood Industry
, pp. 185 - 207
Publisher: Cambridge University Press
Print publication year: 2013

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