Pricing Insurance, Fairly

Abstract

Insurance is one of the oldest and most ubiquitous financial products, and numerous industries rely on healthy insurance markets to function. Actuarially, insurance premiums largely depend on the likelihood of making claims (“risk levels”) and the size of potential claims (“coverage needs”). Consequently, when risk levels and coverage needs increase — e.g., when the frequency and severity of natural disasters increase due to climate change — so too should premiums. Yet consumers typically believe it is unfair for insurers to increase premiums, triggering a host of market distortions (and even market failure). How, then, do consumers believe insurance should be priced? Across 10 preregistered experiments (N = 6,379), we show that consumers view it as less fair for insurers to increase premiums when risk levels increase than when coverage needs increase, holding expected value constant. Additionally, we explore the implications of this distinction for purchase intentions, the acceptability of price discrimination, and support for insurance mandates. Finally, we propose a novel mechanism to explain these beliefs: risk levels may feel less personally controllable than coverage needs. As such, our work not only sheds new light on the psychology of insurance but also offers new insights into the antecedents of price fairness.