Examination Number: B030015
Course: Economics 2
Course Organiser: Michael Watts
Date of Submission: 30/01/2014
Question
Why are more people who are at risk of suffering losses from disasters (both natural and man-made) not insured against them, and what policies might increase the prevalence of insurance against catastrophic losses?
Word Count: 1941
Introduction
Insurance is the one of the world's oldest financial tools. Traders have practiced it since as long as 3rd millennia BC. When operating under a certain assumptions and circumstances, it proves to be a tool to pool risk amongst a set/category of people. Insurance as we know it today traces its origins to the 17th century in the United Kingdom. Research in modern insurance has grown and expanded from finance to behavioral economics.
In order to understand the behavioral patterns with respect to buying insurance and the reasons behind these exemplary behaviors, it is imperative to understand the benchmark models of insurance.
The benchmark models of demand and supply play an almost equal role in determining what decisions the buyer and seller of the insurance make. These decisions heavily depend on the behavioral patterns in the real world and this is where the behavioral economics is intertwined with classical economics.
Benchmark model of Demand
The benchmark model of demand (for insurance) is a classical approach. This model assumes that it is in the best interest of the consumer to maximize his/her expected utility. The expected utility theory also explains why buyers perceive a 'sure thing' as more desirable when compared to uncertain risk. Even though this model is basic and does not account for real world behavior, it still serves as a great starting point when discussing demand side inconsistencies. (Kunreuther, Pauly, & McMorrow, 2013)
According to the expected utility theory, risk-averse buyers of insurance are ready to...