IAI Actuarial Core Principles · Business Economics · Consumer demand and behaviour
Many individuals buy extended warranties and low-excess insurance even when the expected payout is well below the premium. Which behavioural explanation is most directly consistent with this?
Loss aversion best explains it. People feel losses more strongly than equal gains, so they pay premiums above expected claims to avoid even small chances of loss. A rational expected-value maximiser would not pay such a premium.
- ALoss aversion, where potential losses are weighted more heavily than equivalent gainsCorrect
- BPerfectly rational expected-value maximisation
- CGiffen good behaviour
- DDiminishing marginal cost of production
- Complete information in the market
Explanation
Loss aversion makes people overweight the possible loss, so they pay more than the expected value to avoid it. Pure expected-value maximisers would not overpay. The other options are unrelated to the behaviour.
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