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

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.

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.

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.

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.

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.

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.

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.