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The Last Word
Does Insurance Cause Some People to Lie? Behavioral Economics Has the Remedy

Some 24% of consumers think it’s acceptable to pad an insurance claim—at least one insurer is fighting back with a new business model.
  • John Weber
  • December 2021
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By understanding and applying the principles of behavioral economics, insurance companies can increase customer satisfaction and ultimately increase profitability, according to a recent study from Celent. Andrew Schwartz, an analyst at Celent and the author of the study, Applying Behavioral Economics to Insurance, discussed the findings with AM Best Audio. Following is an edited transcript of the interview.

What is behavioral economics?

The central message of behavioral economics is that humans do not always make rational choices that will maximize utility and that we're often motivated by things like heuristics, which are rules of thumbs and biases. However, many of these irrational choices are quite predictable through the application of behavioral economics.

Andrew Schwartz

Andrew Schwartz

Your study examines why insurance causes some people to lie. Why does it?

The very premise of insurance goes against our present bias heuristic, which means that we tend to value short-term gains. When someone pays a premium and a loss doesn't occur, they might perceive the insurance as an unwise investment because there's no tangible return. As a result, the policyholder may become resentful because they view their insurance policy as a monthly sunk cost rather than as a mitigation tool.

Above all, there is an adversarial business model, because the carrier and the policyholder both are unsatisfied and they think that the other one's goals are not aligned with theirs. Obviously, for the policyholder, the goal is to pay a policy and quickly become indemnified and made whole in a time of need. For the insurance company, the incentive, and it's not necessarily an evil one, is the perception of the policyholder to probably maximize profitability.

That misalignment leads to some people rationalizing cheating and potentially padding a legitimate claim because they feel like they aren't given the value that they're needed. An interesting statistic was that 24% of respondents in an Insurance Research Council poll said that they thought it was acceptable to pad an insurance claim by a small amount to make up for deductibles that they're required to pay.

Are insurers buying into the concept of behavioral economics?

Lemonade has coined themselves a behavioral economics carrier. They have tried to remove the misaligned carrier-policyholder dynamic by changing the fundamental business model. They tell the policyholder that they retain a flat 25% of premiums to cover expenses, 15% is used to cover reinsurance, and the remaining 60% is set aside to settle claims. Their excess profits are donated to a preselected charity, known as their giveback prop. The policyholder can choose from 34 nonprofits, select the one where they want to earmark their excess premium.

That's going to incentivize a more honest claim because the policyholder's cheating the charity of their choosing if they've had a claim. Now if you look at the actual process, it's clear that what Lemonade is doing also is improving the customer experience and reducing fraud.


AM Best Audio

Click here to listen to the interview with Andrew Schwartz.


John Weber is a senior associate editor. He can be reached at john.weber@ambest.com.



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