The Nudge Theory of Behavioral Science and Insurance

Behavioral insights can reveal how small changes can yield a big all-around improvement. Nudges offer a way towards discarding of the status quo in favor of end-to-end digitization.

Behavioral economists combine elements of economics and psychology to understand the irrational factors, beyond logical reasoning that steer buying behavior. These are habits, emotions, willpower, framing of alternatives, and the ability and need to trust someone. Through an understanding of how these factors drive behavior, companies can create targeted interventions that ‘nudge’ consumers to make better, safer, easier, more economical choices, without restricting their freedom to decide against the nudge. This is the core of what is called the Nudge Theory.

Over the past decade, nudging has been deployed across public and private sectors. Prominent institutions, such as Morningstar, Walmart, and the governments of UK and US, are known to have successfully applied nudging techniques. A sizable number of insurers have also begun to employ the tactic.

So how can insurers benefit from the application of a theory, which says that subtle interventions can guide choices without restricting them, and use it for the benefit of their customers?

What is the Nudging?

Richard Thaler, the father of behavioral economics, and 2017 Nobel Prize winner, in his core work on ‘nudges’ suggests — that the investment in anything, where the costs are borne now, but the benefits borne later result in most people doing extremely little. It is a common problem. We know what is good for us, but we don’t always do it. Unfavorable behavior like procrastination, a preference for instant gratification over longer-term benefits emanate from this.

A nudge is a subtle policy shift that encourages people to make decisions that are in their broad self-interest. It is not about punishing people financially, if they don’t act in a certain way, but making it easier for them to make a certain decision or act a certain way.

And Thaler says that rare, difficult choices are infact good candidates for ‘nudges’. Recent examples of successful nudging are as diverse as increasing pension contributions, organ donations, and even bathroom hygiene.

Nudging Consumers to Choose Insurance Products

Simply saying, “digitize your paper-based insurance processes, tomorrow will be better we promise,” might not be enough, and nudging can prove to be an effective catalyst for increased digitization in insurance as well.

According to Finalta, a McKinsey-owned leading global expert on financial services — in a pilot study by a German multiline insurer, when nudging based on experience, scientific insights, and common biases was deployed, encouraging results emerged.

  • More than 30 percent of callers accepted the company’s offer, topping the rate achieved by their top performers.
  • The acceptance rate of the customers’ liability counterparties, known to be difficult to convince, increased from around 10 percent to around 30 percent.
  • And when nudging was rolled out across its entire claims operation, a claims ratio decrease of 2 percent for motor via a reduction of claims cost was seen.

For digitizing insurance, the key areas, which stand to benefit from nudging are product design, claims, sales, and ecosystem building.

Product Design

New, simple, understandable insurance products that promote customer trust can benefit from built-in nudges designed to improve customer satisfaction and retention. For instance, it can help insurers tackle what is known as projection bias — the tendency of a policyholder to cancel a contract after a lengthy period without claims. By including a cooling-off period in the product’s cancellation policy, customers who would otherwise impulsively cancel coverage have the space to change their minds and keep their contracts. The potential of nudging in the design of property and casualty (P&C) policies is even higher, as these decisions are often driven by emotion.

Claims

Nudging can increase customer acceptance of settlement or repair recommendations. It can also help prevent fraudulent claims and engage customers in loss prevention. Techniques, such as suggesting a package of prevention measures, instead of promoting each measure individually may be effective for P&C.

Sales

Nudging customers is common in sales across various industries to increase customer satisfaction, confidence in the quality of the product, and overall trust in the provider to resolve issues quickly. Applications like matching customers with company representatives from similar demographic or psychological profiles are in practice. Industries that employ nudging techniques have increased cross selling by as much as 30 percent.

Ecosystem Building

Linking insurance offerings to a much broader range of partner products and services is seeing widespread adoption by providers. Such ecosystems have become crucial for wider customer acquisition on digital platforms, with ecosystems built around smart homes, health and wellness etc. Nudging can be particularly useful in building insurance ecosystems, as participants can refer their customers to relevant partners. Especially, over digital channels, nudges can be easy to implement and personalize, making nudges quite impactful.

Today, several insurance companies have already begun to integrate nudging techniques into various points along their value chain. By incentivizing targeted changes, nudging can initiate structured approaches to selecting good use cases. If the full potential impact of nudging is acknowledged, insurance companies may even institutionalize nudging capability in dedicated units, and ensure that behavioral science penetrates everything they do.

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