Regulating Consumer Demand in Insurance Markets
Daniel Schwarcz
In recent years it has become increasingly clear that risk aversion cannot by itself explain how and why individuals purchase insurance. From the perspective of risk aversion, individuals tend to purchase insurance when they should not, refuse to purchase insurance when they should, prefer sub-optimal payouts, and allow irrelevant considerations to influence their insurance preferences. This article considers the normative implications of these ‘insurance demand anomalies’. It argues that many observed deviations from traditional theory are likely the result of mistakes, in the sense that consumers would act differently if they possessed perfect information and cognitive resources. From this perspective, regulatory interventions designed to improve consumer decision-making about insurance are potentially desirable. At the same time, the article argues that some insurance demand anomalies may actually reflect sophisticated consumer behaviour. In some cases, seemingly puzzling insurance decisions may help consumers manage emotions such as anxiety, regret and loss aversion, while in other cases they may represent valuable commitment strategies. Because consumers’ insurance decisions may reflect sophisticated rather than mistaken decision-making, regulatory interventions that limit consumer choice are normatively troubling. Given these conflicting explanations for risk aversion’s failure as a descriptive theory of consumer demand in insurance markets, the article explores a spectrum of ‘libertarian-paternalistic’ regulatory interventions. It argues that regulatory strategies that aim to encourage presumptively welfare-maximising insurance decisions without restricting individual choice represent a promising and normatively defensible opportunity for improving consumer behaviour in insurance markets.
