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Do customers opt for insurance products with a simplified loss settlement logic?

Laurenz Hommel,H. Schmeiser

Published 2025 in Risk Management & Insurance Review

ABSTRACT

Property and Casualty (P&C) products with a simplified loss settlement logic (SLSL) can reduce insurers' combined ratios by up to five percentage points, as they lower underwriting and claims administration costs. However, these products introduce basis risk for policyholders. As shown in the theoretical section of our paper, policyholders who use an exponential utility function tend to combine traditional indemnity insurance with SLSL‐based insurance to mitigate this risk. In the empirical section, we investigate willingness to pay for SLSL‐based insurance using a behavioral experiment involving a low sum insured. The experiment revealed no significant difference in willingness to pay between indemnity insurance and SLSL‐based products. This could be for a number of reasons, including that participants do not fully understand basis risk and its implications, the convenience of insuring with an SLSL product outweighs basis risk, or they perceive products to be of similar value if basis risk is not severe. Insurers could test demand for SLSL insurance in a pilot scheme. However, they should proceed with caution to mitigate the risks of potential litigation and reputational damage.

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