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Imagine flipping a coin. If it lands on heads, you win $100. If it lands on tails, you lose $100. Would you take this bet? Most people wouldn’t, even though the expected value of the bet is zero.

But what if we changed it a little? Now, if it lands on tails, you still lose $100, but if it lands on heads, you win $200. More people take this bet. This is because of a concept called loss aversion. People tend to feel the pain of a loss more acutely than the pleasure of a gain of the same size. In fact, people typically need the win to be 1.5 to 2 times the value of the loss to act on the bet. Loss aversion is just one concept in behavioral economics, and many more exist.

Behavioral economics is changing the insurance industry, taking the guesswork out of creating new products and interacting with customers. By understanding how people make decisions and why, Insurtech companies are developing products that are more relevant, engaging, and personalized to customers’ needs. With this in mind, let’s explore the key concepts of behavioral economics and how they are being applied in the Insurtech space to create innovative solutions.

What is behavioral economics?

Behavioral economics challenges the traditional assumption that people always make rational decisions. It recognizes that emotions, biases, and social influences often play a significant role in our choices. By understanding these psychological factors, behavioral economics offers insights into how people perceive risk, make decisions, and respond to incentives. This knowledge is invaluable for developing insurance products that better align with customers’ needs and preferences.

The key concepts of behavioral economics

Behavioral economics is grounded in several key concepts that provide a framework for understanding human decision-making. These are:

• Loss aversion: We touched on this above. People tend to weigh losses more heavily than gains. This can lead to risk-averse behavior, even when the expected outcomes are favorable.
• Anchoring bias: Our decisions are often influenced by an initial reference point or “anchor,” even if it’s irrelevant. For example, if you’re buying a car and the salesperson initially suggests a price of $30,000, this will influence your perception of a “fair” price, even if you know the figure is inflated. You might negotiate down from $30,000, but the original figure will still subconsciously anchor your thinking.
• Framing effects: How information is presented can significantly impact our choices. For example, people may be more likely to choose a product labeled “95% fat-free” than one labeled “5% fat.”
• Status quo bias: People often prefer to maintain the status quo rather than make changes, even if the change could be beneficial.
• Overconfidence bias: We tend to overestimate our abilities and knowledge, leading to suboptimal decisions.
• Social proof: People are more likely to make decisions that are consistent with the behavior of others.
• Scarcity: When resources are perceived as limited, they become more valuable, even if their intrinsic worth hasn’t changed. For example, the fear of missing out can drive consumers to purchase limited edition products at a premium price, even if they don’t need them.

How behavioral economics influences the Insurtech industry

Insurance companies can use behavioral data to offer more accurate and evidence-based products. But more than that, we can use behavioral economic concepts to enhance customers’ decision-making processes and provide genuine value. Here’s how insurers can apply behavioral economics thoughtfully.

Risk assessment and pricing

Overconfidence bias can lead drivers to think they are safer than average, even when that might not be true. This also applies to home insurance, where people might say, leave a door unlocked or a window open because they believe they live in a safe neighborhood.

Data can help insurers counter this bias by providing objective feedback on driving behavior or area statistics. For example, telematics data can track factors such as speed, braking, acceleration, and night driving, allowing insurers to identify risky behavior. Insurers can use this data to educate customers about their driving habits and encourage safer practices. Additionally, insurers can use telematics data to create more accurate risk profiles and offer personalized premiums based on actual driving behavior, rather than relying solely on demographic information.

Lastly, behavioral economics finds that immediate rewards are more compelling than future ones. Insurtech firms often offer immediate discounts or tangible rewards for behaviors that reduce risks, like installing safety devices in homes or cars.

Customized marketing and product offers

Insurers can use framing effects positively by highlighting how insurance protects against potential losses rather than focusing on the cost of insurance itself. Loss aversion also plays a role here. For instance, framing a home insurance policy in terms of peace of mind and financial security in case of natural disasters can help homeowners appreciate the value of insurance during uncertain times, leading to more informed and confident decision-making. We can also use relevant data to remind customers of the losses (cost and destruction) associated with natural disasters.

Studies also reveal that too many choices or overly complex options can lead people to make poor decisions or avoid making a decision altogether. Insurtech companies, therefore, simplify their offerings and use clear, jargon-free language to make their products more accessible. This is particularly important with highly personalized policies. Insurers need to find a way to use data to clearly present a few options to customers, rather than letting data result in offering 100 tailored packages that will turn customers away.

Customer engagement and social proof

Social proof, the tendency of people to conform to the behavior of others, can be leveraged to increase customer engagement. Insurers can highlight the success stories of customers who have benefited from their products or services. This can create a sense of social proof, encouraging other customers to consider similar products or services.

Final thoughts

Behavioral economics is about real people and real decisions. By understanding how people make decisions, insurers can create more personalized, relevant, and engaging products. From risk assessment and pricing to customer engagement and product design, behavioral economics provides a framework for developing innovative solutions that meet the evolving needs of today’s consumers. As the insurance industry continues to evolve, the application of behavioral economics will become increasingly important for driving growth and success.