How Individuals Purchase Insurance: Going Beyond Expected Utility Theory

For insurers to be successful in the long run, they need to put forward an attractive value proposition for insureds and price (sufficiently) for it. To facilitate this, it is best that insurers deepen their understanding of consumer behavior in situations that involve risk. This paper is intended as a survey of the developing economic literature concerning how individuals make choices in the face of risk. It will be shown and illustrated that there are primitives that drive the choice behavior of individuals faced with risk. With understanding of these primitives in mind, a practicing actuary should be able to rationalize observed portfolio profitability or unprofitability, as well as anticipate the effect of some pricing and product changes on the profitability of the affected portfolios.

Keywords: Behavioral Economics; Expected Utility Theory; Committed Consumption; Loss Aversion; Prospect Theory; Consolation Hypothesis