Persistently high profits on “insurance” for small value losses sold as an add-on to other products or services (such as extended warranties sold with consumer electronics, loss damage waivers sold with a car rental, and credit life insurance sold with a loan) pose a twofold challenge to the standard economic analysis of insurance. First, expected utility theory teaches that people should not buy insurance for small value losses. Second, the market should not in the long run permit sellers to charge prices that greatly exceed the cost of providing the insurance. Combining the insights of the Gabaix and Laibson shrouded pricing model with the behavioral economics of insurance, this article explains why high profits for add-on insurance persist and describes the negative distributional and welfare consequences of an unregulated market for such insurance. The article explores four potential regulatory responses: enhanced disclosure, a ban on the point of sale offer of add-on insurance, price regulation, and the creation of a new, on-line market. Drawing on theoretical, empirical, and comparative law sources, the article explains why enhanced disclosure will not work, the circumstances under which a point of sale ban is desirable, and why a new, on-line market is preferable to price regulation in circumstances in which a point of sale ban is undesirable.
Baker, Tom and Siegelman, Peter, "“You Want Insurance with That?” Using Behavioral Economics to Protect Consumers from Add-on Insurance Products" (2013). Faculty Scholarship. 441.