Regulating Consumer Demand in Insurance Markets

In recent years, it has become increasingly clear that Expected Utility Theory (EUT) is a remarkably poor theory of how and why individuals purchase insurance. However, the normative implications of this conclusion have remained largely unexplored. This Article takes up this issue. It argues that many observed deviations from EUT are likely the result of mistakes, in the sense that consumers would act differently than they do if they possessed perfect information and cognitive resources. From this perspective, regulatory interventions designed to improve consumer decision-making about insurance are potentially desirable. At the same time, the Article argues that some deviations from EUT may actually reflect sophisticated consumer behavior. In some cases, seemingly puzzling insurance decisions may help consumers manage emotions such as anxiety, regret, and loss aversion, while in other cases they may represent valuable commitment strategies. Because consumers’ insurance decisions may reflect sophisticated, rather than mistaken, decision-making, regulatory interventions that limit consumer choice are normatively troubling. Given these conflicting explanations for EUT’s failure as a descriptive theory of consumer demand in insurance markets, the Article explores a spectrum of “Libertarian Paternalistic” regulatory interventions. It argues that regulatory strategies that aim to encourage presumptively welfare-maximizing insurance decisions without restricting individual choice represent a promising and normatively defensible opportunity for improving consumer behavior in insurance markets.