'You Want Insurance with That?' Using Behavioral Economics to Protect Consumers from Add-on Insurance Products

61 Pages Posted: 12 Jan 2013 Last revised: 9 May 2014

Tom Baker

University of Pennsylvania Law School

Peter Siegelman

University of Connecticut - School of Law

Date Written: 2013

Abstract

Persistently high profits on “insurance” for small value losses sold as an add-on to other products or services (such as extended warranties sold with consumer electronics, loss damage waivers sold with a car rental, and credit life insurance sold with a loan) pose a twofold challenge to the standard economic analysis of insurance. First, expected utility theory teaches that people should not buy insurance for small value losses. Second, the market should not in the long run permit sellers to charge prices that greatly exceed the cost of providing the insurance. Combining the insights of the Gabaix and Laibson shrouded pricing model with the behavioral economics of insurance, this article explains why high profits for add-on insurance persist and describes the negative distributional and welfare consequences of an unregulated market for such insurance. The article explores four potential regulatory responses: enhanced disclosure, a ban on the point of sale offer of add-on insurance, price regulation, and the creation of a new, on-line market. Drawing on theoretical, empirical, and comparative law sources, the article explains why enhanced disclosure will not work, the circumstances under which a point of sale ban is desirable, and why a new, on-line market is preferable to price regulation in circumstances in which a point of sale ban is undesirable.

Keywords: Consumer Protection Law, After-Sales Service Warranty, Extended Warranties, Add-on Insurance, Insurance Pricing, Sale Ban, Price Regulation, Situational Monopoly, Shrouded Attributes

JEL Classification: D42, G22, K12, K23

Suggested Citation

Baker, Tom and Siegelman, Peter, 'You Want Insurance with That?' Using Behavioral Economics to Protect Consumers from Add-on Insurance Products (2013). Connecticut Insurance Law Journal, Vol. 20, Pg. 1, 2013; U of Penn, Inst for Law & Econ Research Paper No. 13-1. Available at SSRN: https://ssrn.com/abstract=2199569 or http://dx.doi.org/10.2139/ssrn.2199569

Tom Baker (Contact Author)

University of Pennsylvania Law School ( email )

3501 Sansom Street
Philadelphia, PA 19104
United States
215-746-2185 (Phone)

HOME PAGE: http://www.law.upenn.edu/cf/faculty/thbaker/

Peter Siegelman

University of Connecticut - School of Law ( email )

65 Elizabeth Street
Hartford, CT 06105
United States
860-570-5238 (Phone)
860-570-5242 (Fax)

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