Why your clients will buy insurance only after a disaster

Due to six decision biases, consumers will typically not protect themselves against low-probability, high-consequence events until it is too late, a keynote speaker said recently at the CatIQ Connect conference in Toronto.

When consumers decide not to purchase insurance or invest in loss reduction measures prior to a disaster, they are typically guided by one or more of the following six decision biases:

• Myopia
• Amnesia
• Optimism
• Inertia
• Simplification
• Herding

The second bias, amnesia, means that people often forget the lessons of the past, leading them to decide not to undertake necessary measures, said Howard Kunreuther, professor and co-director of the Risk Management and Decision Processes Center at the University of Pennsylvania’s Wharton School.

Kunreuther was the keynote speaker at the CatIQ conference on Feb. 5. He was discussing the book The Ostrich Paradox: Why We Underprepare for Disasters, which he co-wrote with Robert Meyer.

“People buy insurance after a disaster, by the way, not before, unless they are forced to buy it,” Kunreuther said. “Then they have it for a few years and say, ‘God, I’ve wasted all these premiums. Look at all the things I could have done with the money that I’ve spent on insurance. I’m going to cancel my policy.’”

One of the biggest challenges insurers face, Kunreuther said, is convincing consumers that the best return on an insurance policy is no return at all. “Celebrate you haven’t had a loss. Very hard to do.”

On a personal note, Kunreuther said he bought his first set of battery cables only after his car didn’t start. “Battery cables weren’t part of my agenda when I bought my first car many years ago.” Generally speaking, people focus on the losses after the disaster, not beforehand.

Besides amnesia, five other biases play a role in being underprepared:

• Myopia: The focus is on short-term horizons, such as what is going to happen tomorrow, or even next year. “The real challenge with focusing on short-term horizons is that so much of what you want to do in preparing for disasters is to invest in adaptation,” Kunreuther said. “How do you adapt to climate change? How do you adapt to the flood problem? How do you reduce [and] mitigate the losses? These costs can be high. So if you’re only thinking about the next year or two or three, you’re going to say, ‘I don’t want to put my money into this, I’m not going to get a payback.’”
• Optimism: This involves underestimating the likelihood of extreme events. “They’re below our threshold level of concern, we’re not going to pay attention to them,” Kunreuther said. “Even if they’re low, you may want to put some energy into thinking about them, as Hurricane Harvey illustrated.”
• Inertia: Describes not wanting to change from the status quo, because there is a lot of uncertainty in change. “There is loss aversion, so if you lose 10 dollars, you’re feeling a lot worse about losing the 10 dollars than gaining 10 dollars.”
• Simplification: People don’t like to attend to many different things. In risk, the critical issue is probability and consequence. “Now if it turns out that you’re following the notion of being optimistic and you say, ‘Look, the probability is so small, I’m not going to worry about it,’ you’ve simplified your decision very nicely, but you’re not going to focus on the consequences at all,” Kunreuther said. “You’ve already tuned out of the events and you basically said, ‘I’m not going to pay attention to what might happen.’”
• Herding: This happens when you follow what neighbours, friends or other companies are doing. “We tend to focus on what others are doing, but they might not know any more than we do. Everyone is herding together and you got a social norm of not taking action and that is a real, real challenge to deal with.”