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How does Prospect Theory impact your decision to buy health insurance?

Team AckoJan 27, 2023

Some people are uncertain about buying health insurance coverage. This uncertainty could be a combination of limited information, high cost, and personal factors. Researchers have studied this behaviour and created theories that can influence a buying decision, including The Prospect Theory, The Theory of Planned Behaviour, and The Elaboration Likelihood Model. The following article focuses on the Prospect Theory and its impact on your decision to buy health insurance. Read on to learn more.

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Contents

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What is Prospect Theory?

A behavioural economic theory called Prospect Theory explains how people decide when faced with uncertainty. The hypothesis, which was created by psychologists Amos Tversky and Daniel Kahneman, provides an alternative to the conventional economic presumption that people make rational decisions.

  • It is based on the idea that people are more likely to take risks when the potential outcomes are perceived as gains and less likely to take risks when the potential outcomes are perceived as losses.

  • The theory also suggests that people are more sensitive to losses than gains of the same magnitude.

  • One of the key insights of Prospect Theory is that people often make choices that are not consistent with rational decision-making. 

Prospect Theory has significantly impacted the fields of insurance, economics, finance, and behavioural psychology. The example in the following section will help you understand this theory in detail.

How does Prospect Theory influence people to purchase health insurance?

Here’s an example of how Prospect Theory can affect a person's decision to buy health insurance. They may weigh the cost of the insurance premium against the likelihood of getting sick or injured during the policy period and consider their personal history for the number of medical events that occurred in the past. If they perceive the number is low, they might not buy a health plan, as the premium may seem too high for the perceived benefit. Here, they perceive the potential outcome as a loss and most likely not buy the policy.

On the other hand, if the person perceives the likelihood of getting sick or injured as high, they might be more likely to purchase health insurance because the benefit of having coverage might be higher than the premium. Here, the potential outcome is perceived as a gain.

What is a significant disadvantage of not buying health insurance?

One of the most significant disadvantages of not having health insurance is financial risk. Medical treatment can be expensive, and without insurance, you may have to pay for all of your medical expenses out of pocket. This can be a significant burden, especially if you have a severe illness or injury that requires expensive treatment.

5 reasons why people avoid buying health insurance

The following are some reasons why people in India may avoid buying health insurance.

1. Cost

One of the biggest reasons why people may not buy health insurance is the cost. Health insurance premiums can be expensive, and some people may not be able to afford them.

2. Lack of awareness

Many people in India are unaware of the benefits of health insurance and may not understand the risks of not having insurance. This lack of awareness can prevent people from buying insurance, even if they can afford it.

3. Misconceptions about health insurance

Some people may have misconceptions about health insurance, like it is only for people who are unwell or that it is unnecessary because they are healthy. These misconceptions can prevent people from buying health insurance.

4. Limited availability 

In some parts of India, health insurance policies/services may not be available as easily and effectively as they are in cities. 

5. Government programs

The government often provides basic healthcare services through public hospitals and clinics in India. Some people may rely only on these services and may not see the need to buy additional health insurance.

How does Prospect Theory help health insurance companies?

Insurance companies can use Prospect Theory to design more appealing policies for customers by highlighting the potential gains of having insurance. They can also use the Prospect Theory to make the customers aware of the potential losses of not having insurance — for instance, the high costs of medical treatment for an unexpected illness or injury. Understanding how Prospect Theory impacts customers' decisions can help insurance companies increase their sales and business. 

How does Prospect Theory differ from Expected Utility Theory?

Prospect Theory and Expected Utility Theory both help in understanding how people make decisions when they are uncertain. However, they have some key differences.

Expected Utility Theory assumes that people make decisions by considering the possible outcomes of their choices and then choose the option with the highest expected utility. Here people are assumed to be rational and consistent in their decision-making, and that they always make choices that maximise their expected utility.

Prospect Theory, on the other hand, is a more realistic approach to decision-making when a person is uncertain. This theory does not assume that people are always rational and consistent. It recognises that a person can be influenced by various factors, such as the likelihood of different outcomes and the potential losses and gains related to those outcomes.

One key difference between the two theories is that Prospect Theory considers how people perceive risk. In Expected Utility Theory, the probability of different outcomes determines the risk. In Prospect Theory, however, people's perceptions of risk are subjective and can be influenced by their experiences and biases.

Frequently asked questions

Here are some common questions and answers about the Prospect Theory.

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How does Prospect Theory differ from traditional economic theories?

Prospect Theory recognises that people may not always make rational decisions. It differs from traditional economic theories, which tend to assume that people are rational and will always make decisions that maximise their utility.

What are some criticisms of Prospect Theory?

Some of the main criticisms of Prospect Theory are as follows.

  1. The theory is based on a limited set of experiments. 

  2. The theory relies on subjective evaluations of utility. However, people's assessment of utility may vary widely. 

  3. Prospect Theory focuses on how people evaluate potential gains and losses, but other factors, such as emotions, personality, and social norms, can also influence decision-making.

  4. Despite its popularity, Prospect Theory has been found to be an imperfect predictor of how people actually make decisions in real-world situations.

How is Prospect Theory used in practice?

Prospect Theory has been applied in many fields, including economics, insurance, finance, and political science. In economics, for example, Prospect Theory can be used to explain why people make certain decisions regarding investments, savings, and consumption.

Disclaimer: The content on this page is generic and shared only for informational and explanatory purposes. It is based on industry experience and several secondary sources on the internet, and is subject to changes.

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