Behavioral economics in insurance underwriting is becoming more prevalent, especially with the rapid adoption of digital experiences. This article breaks down the current landscape of behavioral economics in insurance and how insurers and reinsurers can start using it to improve their underwriting procedures.
First, what is Behavioral Economics?
Contrary to early economic belief, humans don’t always make rational decisions. It’s safe to say thay we do weird things and make weird choices all the time — consciously and subconsciously.
So how do economists predict our erratic behavior? They use predictive models and predictive analytics based on behavioral economics. Insurers can also use behavioral economics in insurance underwriting, but more on that in a minute.
Behavioral economics integrates the fields of psychology and economics to examine how people make choices, and why they make them. Usually, our choices are shaped by external and internal factors that we’re completely unaware of.
Examples of Behavior Economics in Our Day-to-Day Lives
Let’s take a look at what behavioral economics looks like in our day-to-day lives.
“It’s fine, I didn’t try that hard.”
Self-handicapping is a principle used to protect one’s self-esteem. The strategy involves omitting effort in order to manage expectations (or in other words, protect one’s self-esteem.) For instance, if you put in a ton of hours studying for an exam, but told your friends you barely studied, you’d be setting up a guard rail in case you got a bad score.
“It’s not really stealing, is it?”
Rationalized cheating is a principle we use to justify our behavior. For instance, if you took a stack of post-it notes home, you may justify that it’s okay (not stealing) because you didn’t steal any cash. Behavioral economic studies summarize this as a rationalized willingness to cheat, and in theory, the more you “cheat”, the more psychological distance you’ll put between yourself and your actions.
“It’s your idea, not mine.”
Anchoring is the principle of dropping a thought into someone’s mind, so they take the action you want later. We’ve seen this in marketing campaigns, modern parenting, and Dwight’s diabolical plan in The Office. For instance, a McDonald’s billboard might display their newest burger two miles before the exit to their store, and so you exit to get one, even though you weren’t feeling hungry a minute ago. Or, a parent might try to convince their toddler to eat a new food by reading them a book about it the night before. Behavioral economics proves that one is likely to make a decision (rationally or not) when the idea was planted ahead of time.
Examples of Behavior Economics Online
According to the National Library of Medicine’s investigation of behavioral economic theory to problematic internet use, “problematic Internet use is a reinforcer pathology reflecting an overvaluation of an immediately acquirable reward relative to prosocial and delayed rewards.”
What we can take away is that consumer expectations have drastically shifted as we spend too much time on the internet. Because we have access to a world of information — almost instantaneously — our “reward center” is constantly firing. As a result, the modern consumer expects instant gratification.
Instant gratification isn’t all bad, but in cases of insurance applications, underwriting, and filing claims, it can be. Behavior economics in insurance underwriting has shifted with this overly engaged “reward center” as we see a direct correlation with applicants being honest in their online applications. This brings us to the next section observing, when do people act dishonestly?
When Do People Act Dishonestly?
You’ve probably heard the phrase “dance like nobody’s watching.” While this phrase is used to empower people to care less about the opinions of others, there’s also a darker truth that contributes to its power: we act differently when we think no one’s watching.
In a study observing computer gamers, researchers found that the gaming participants behaved more selfishly and rationally when interacting with computers alone. When another gamer was added (interacting only through the screen), subjects often learned how to exploit each other, even with minimal information to work off of. Computer players engaged in more aggressive “strategic behavior” when interacting online versus face-to-face.
So what does this have to do with insurance underwriting?
What can behavioral economics in insurance underwriting teach us about customer integrity while interacting with our online forms? While the computer gamers from the study above don’t necessarily represent the predicted behavior of insurance customers, it’s reasonable to make some connections.
Basic principles of behavioral economics suggest that, in addition to acting differently when no one’s watching, we often subconsciously justify our actions to convince ourselves that we’re not bad people. Dan Ariely, a prominent voice in BE, says that “people will only be dishonest to the point they can still feel good about themselves.”
One example of this challenge for insurers reveals itself through “smoker’s amnesia.” Around 47% of smokers falsely record their smoking status on applications. This is called tobacco nondisclosure, and it causes life insurance providers lose $3.4 Billion in estimated total premium every year. But why?
Think about it…if you had smoked a cigar at your kids graduation party a few weeks before applying for life insurance, would you disclose it? If you’re a social smoker or only smoke when you drink, would you consider yourself a smoker? If you recently quit smoking, would you report that you were a smoker if you knew it would cost you 2-3x more in monthly cost?
We know that people don’t like to admit personal behavior that isn’t socially acceptable as is. Now, add in financial repercussions and you’ve got a whole new animal.
So what can insurance underwriters do about it? They can start by adjusting the questions on their applications.
Multi-part Questions: Multi-part questions are ones similar to: “Have you been diagnosed, treated, or received medical advice for any of the follow conditions…” These kinds of questions require more effort from applicants rather than the preferred quick and easy (instant gratification) modern consumers are looking for. In addition, multi-part questions leave room for telling partial truths (which in some cases, leads to ‘soft fraud.’) Instead, underwriters should consider changing multi-part questions to short and straightforward questions that leave no gray area for the applicant.
Incentive Questions: Applicants presented with an obvious incentive are less likely to answer honestly. For example, if an application section starts with a statement like, “In order to qualify for a premium auto insurance rate, applicants must be able to answer “No” to the following questions…” — Guess what your applicants are going to answer with?
Instead, underwriters should provide less information on the front end, and then follow up to ask more questions in the next qualifying procedure.
AI and Behavioral Economics in Insurance Underwriting
Improving the application process with more targeted questions is one step in the right direction, but that’s only a piece of the puzzle. Insurers must also understand that AI plays a critical role in helping us understand user behavior. Combining AI and behavioral economics is quickly becoming a crucial piece in the underwriting puzzle.
As carriers continue moving from manual to accelerated underwriting, knowing what your applicants are doing when “no one’s looking” lets you know who to accelerate and who to further qualify can have a huge impact on your loss ratio.
ForMotiv helps companies expand opportunities for accelerated underwriting and straight-through-processing by analyzing the way users physically fill out digital applications, interact with specific questions, and ultimately help determine the likelihood that the answer is truthful.
Armed with this actionable intelligence, ForMotiv’s customers are able to nudge users to subtly intervene while they are still in the application to elicit more honest disclosures. McKinsey has a solid article on this here.
Given the real-time nature of ForMotiv’s solution, dynamically adding or removing friction during the underwriting process has succeeded in improving disclosures across Life and P&C carriers.
Schedule a call to see how ForMotiv will improve your company’s underwriting process with our Behavioral Data Science solution.