Can behavioural economics change the way consumers think about insurance?

Let us get one thing out of the way straight out of the blocks: insurance is a grudge purchase. No one likes handing over money in case something happens. Sure, they are grateful to have it when something bad happens, but most people will have that nagging voice in their head saying, “What if nothing bad ever happens?”. That has always been the case traditionally, at least. But it does not have to be that way.

By using principles learnt from behavioural economics, it is possible to help people overcome their internal biases. In doing so, it is possible to take insurance from something that people think of as necessary but annoying to something that they are actively engaged with and which they view as an intrinsic part of their day-to-day lives.

The basics of behavioural economics and biases

Before looking at how that might work, it is worth getting a basic grasp of behavioural economics and internal biases.

Behavioural economics is in essence, a field of study that brings together psychology and economics to understand why people behave in the ways they do. Unlike traditional economics, it does not assume that people always act rationally. Instead, it recognises that people’s patterns of behaviour are impacted by internal biases as well as emotions (such as fear) and social influences.

Internal or cognitive biases can best be thought of as the shortcuts your brain takes instead of rationally thinking through every decision or action in full detail. It’s also why you might seek out information that reflects your beliefs about the world and struggle to accept information that contradicts it (this is known as confirmation bias).

While it is possible to overcome these biases yourself, it is not always easy. That is especially true if you are not aware of them in the first place. But by understanding them and applying behavioural economics principles, it is possible to nudge people away from some of their most dangerous biases.

The problem with present bias

One cognitive bias that the insurance industry should be particularly aware of in its customers is present bias. Present bias is the internal force that causes so many of us to prefer immediate rewards or payoffs over delayed gratification.

That’s not to say that we’re not thinking about the future when this bias kicks in. Many of us are. However, most of us also think that in the future we will have more self-control. That is why we always start a diet next week or start saving next month. This is something known as naive present bias – we optimise for happiness and comfort now with the erroneous belief that we will take the uncomfortable actions necessary to achieve our long-term goals tomorrow.

This preference for instant gratification causes a host of problems for us including excessive debt, procrastination on our goals, and sacrificing long-term health for short-term pleasure, to name but a few.

In the insurance sector, present bias can result in people delaying getting insurance or not choosing a comprehensive enough package because they have underestimated the risks they will face in the future.

Little nudges can make a difference

While the insurance industry cannot help its customers overcome present bias entirely, it can use nudging to help drive the kind of behaviour that it makes people avoid confronting their need for it. Interestingly, this can be done by using many of the same impulses behind present bias.

A car insurer might, for instance, offer rewards for good driving on a weekly or monthly basis, either in the form of cash or by giving customers discounts on their premiums (or both). It might also use the full range of communication tools available to it, to offer personalised insurance recommendations based on individual needs and circumstances and provide timely behavioural reminders to encourage the kind of safer driving behaviours that will pay off in the long term.

It’s a big leap forward, especially for an industry that hasn’t always excelled at communicating with its customers. But for the insurers who understand how behavioural economics can help ensure that customers are getting the coverage they need and acting in their own long-term best interests, the rewards (particularly when it comes to customer loyalty) are rich.