Psychologist Daniel Kahneman was awarded the 2002 Nobel Prize in Economics for his research into how human beings behave when making economic decisions.
His findings challenged assumptions that humans act rationally in these situations. Since then the psychological study behind judgment and decision-making in financial situations has become known as behavioral economics, and has spread to the fields of social science, marketing, economy, finance and insurance.
The purpose of this article is twofold: first to report some of the main effects and biases observed and documented in this ongoing research, showing how these may apply to the insurance industry from distribution to claims. This includes information about where the research confirms behavior long recognized by the industry. Second, this article looks at the methodology used in this research, comparing a “laboratory experiments” approach to a more traditional, theoretical approach that is common in economics and in insurance where a model is built and then tested on available data. As our industry has been exposed to the “lab” approach from behavioral economics studies we are starting to see potential in how such methodologies can be applied to the distribution of financial and insurance products. Some interesting examples of phenomena studied by various authors are:
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