Overconfidence and Optimism Biases in Insurance Purchasing Decisions and Overcoming Them Through Nudge

Introduction

The widespread academic acceptance of Behavioral Finance is attributed to the seminal work of Kahneman and Tversky (1979). Undertaking psychological studies with the aim of scrutinizing rationality, they subsequently formulated a new theory termed 'Prospect Theory' (Bachmann, De Giorgi, & Hens, 2018). Kahneman & Tversky have served as a catalyst for a new generation of research employing insights from cognitive psychology to enhance financial and economic models. Prospect Theory, as an alternative to conventional financial models, furnishes a more robust explanation for observed human behaviors (Pompian, 2012). The theory underscores a nuanced framework, delineating a complex interplay of various biases aimed at comprehending investor behavior. The research conducted by Kahneman & Tversky (1979) has discerned that investors' decision-making processes encompass an array of cognitive biases that influence their behavior (De Bondt & Thaler, 1985; Chang, 2011). Furthermore, their findings indicate a systematic deviation in decisions made under conditions of uncertainty from the predictions of traditional economic theory. In this context, the Prospect Theory put forth by Kahneman and Tversky (1979) has engendered a paradigm shift by integrating diverse cognitive factors into the decision-making process, imparting a distinct dimension to individuals' financial decision-making. Cognitive biases, generally arising from perceptual errors in the storage, correction, and processing of information or in the formulation of decision problems (Hilbert, 2012) have become a focal point, underscoring the increasing significance of endeavors to rectify the deleterious impacts of cognitive biases on the decision-making process.

Within the academic discourse concerning the insurance sector, numerous cognitive bias studies predominantly center on the adverse effects of overconfidence on insurance purchasing behavior (Bregu, 2022; Huang & Luo, 2015; Sandroni & Squintani, 2004). Furthermore, studies exist in the literature that contextualize the “overconfidence” bias within the realm of the “optimism” bias (Coats & Bajtelsmit, 2021; Sandroni & Squintani, 2007). Consequently, this paper scrutinizes the interplay between behavioral finance and insurance, deliberating on the impact of overconfidence and optimism biases on insurance purchasing behavior. Subsequently, practical interventions to ameliorate the influence of overconfidence and optimism biases in insurance purchasing decisions are examined within the framework of Thaler & Sunstein (2008) “Nudge” theory.

Thaler & Sunstein's (2008) book, “Nudge: Improving Decisions About Health, Wealth, and Happiness,” is grounded in the assertion that individuals need to be nudged toward decisions that will enhance their lives, making them more prosperous, healthier, and more liberating. In this study, the application of choice architecture in the field of behavioral finance is explored. The “Nudge” theory, developed based on the theoretical framework of behavioral finance, aims to address human irrational behavior and cognitive biases. Nudging can be defined as a choice architecture that guides individuals' behavior to predict their choices without prohibiting options or significantly altering existing economic incentives. Choice architecture refers to the structure involving individuals or institutions that organize the subjects or issues individuals need to make decisions about (Thaler & Sunstein, 2008).