Behavioural Economics: Appropriate Framework for Studying the Life Insurance Market

Abstract

This article rests on establishing a unique standpoint that life insurance products (unlike other financial assets) are purchased for protection, not as an investment for return. This aims at identifying the most suitable theoretical framework to study the life insurance market and to suggest appropriate tools of analysis. Economic and financial theories starting from neo-classical economics, going up to behavioural economics (BE) have been studied vis-à-vis life insurance markets. A distinction has been drawn between BE and behavioural finance (BF). Accordingly, neo-classical economics, standard theory of finance and BF have been found to be inappropriate to understand life insurance as a market. The main theoretical edifice of BE, with a blend of transaction-cost approach and information theoretic approach, is argued to be the right theoretical framework to study the life insurance market, given the idiosyncrasies involved. A novel attempt has been made to create a ‘construct’ to depict how the BE framework is most relevant. It is hypothesised that bounded rationality is adversely influenced by emotions, search costs, intermediaries and socio-psychological influences, to embed behavioural biases and heuristics into life insurance purchase decisions. Combinedly, this leads to demand and supply distortions that create an incomplete market. To test this framework, it has been suggested that Heuristic z-test; Murthy’s Index of Rank Dominance (MIrd & MRird); and logistic regression, be harnessed. These tools would help in measuring market inefficiency and underperformance. Policymakers, the regulator, insurers and buyers alike would benefit from a better understanding of the market.

Keywords: Life Insurance, Neo-Classical Economics, Information Asymmetry, Bounded Rationality, Behavioural Economics, Market Inefficiency

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