Behavioural and Traditional Approaches to Insurance

Abstract

Research Question: In which ways can behavioural economics explain systematic deviations from rational decisionmaking in the insurance market? Which behavioural interventions, i.e., debiasing strategies and nudge measures, can improve the rationality of decisions, individual and social well–being, and market efficiency? Motivation: Insurance plays a central role in financial risk management. However, policyholders and insurers often make decisions that deviate from traditional financial theory. These deviations are systematically influenced by cognitive biases, such as availability heuristics, framing effect, status quo bias, overconfidence, etc. This paper examines why rational choice models fail to describe the actual behaviour of participants in insurance markets, and how psychological mechanisms distort the decision-making process. Building on fundamental papers in behavioural economics (Kahneman & Tversky, 1979; Thaler & Sunstein, 2008), as well as empirical studies in the insurance field (e.g., Kunreuther & Pauly, 2004), the paper integrates these insights to enhance theoretical understanding and practical interventions, with the aim of improving the quality of decisions and market outcomes. Data: The paper uses a literature review methodology and synthesizes findings of selected relevant papers, experimental and field studies on behavioural biases that affect both policyholders and insurance company managers. The time frame covers several decades - from seminal papers (e.g., Kahneman & Tversky, 1979) to the latest empirical research (e.g., Fan, Liu, & Liu, 2025). Tools: To the best of our knowledge, this topic has not been previously investigated in the academic literature in Serbia. The paper is conceived as a review article, with the emphasis on identifying heuristics, cognitive distortions, and the effectiveness of nudge interventions, connecting theoretical knowledge with practical implications for policyholders, insurers and regulators. In this sense, the study represents a good starting point for new research on the impact of psychological phenomena on the Serbian insurance market. Findings: Behavioural factors offer a more realistic and empirically better grounded explanations of insurance-related decisions than neoclassical assumptions of rationality. The behaviour of policyholders and insurers is systematically influenced by cognitive distortions, which results in underinsurance, mispricing of premiums, suboptimal design of insurance products and ineffective risk management. Interventions based on nudge approach - such as defaults or messages based on social norms - can effectively improve the quality of decisions and increase participation in insurance schemes. However, the nudge approach has limitations, especially regarding ethical issues and transferability across different cultures and contexts. Optimal public policy design requires a balance between libertarian paternalism and regulatory oversight, while ensuring both protection and freedom of choice. Contribution: The paper contributes to the literature as follows: integrates the insights from behavioural economics and insurance theory into a cohesive analytical framework; highlights the dual behavioural distortions that affect both policyholders and insurers; proposes a set of evidence-based interventions aiming to improve both individual and market level outcomes; offers a critical evaluation of the ethical and institutional limitations of behavioural interventions in the insurance sector; and informs policymakers and industry practitioners about how behavioural principles can improve the design of insurance products, transparency and efficiency of insurance markets.