Willingness to pay for sustainability and customer risk preferences in the motor insurance market
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School of Business |
Master's thesis
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Date
2024
Department
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Mcode
Degree programme
Economics
Language
en
Pages
72+25
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Abstract
Business sustainability is becoming increasingly important worldwide, including for financial sector actors like insurance companies. In this context, what is the willingness of customers to pay a premium for a sustainable insurance product, over and above the price they already pay for a conventional insurance product? Does this willingness to pay for sustainability differ by background characteristics that affect customer’s risk preferences? If so, can this willingness to pay be used as a screening mechanism to distinguish between customers of different risk types and thus devise a more efficient pricing policy based on appropriate price discrimination? These are the key questions that this body of work aims to address. Key to answering them is understanding the kind of customer selection that exists in a particular insurance market. Both the cases of adverse and advantageous customer selection, as proposed by Einav and Finkelstein in their work on insurance markets, are explored and developed further to incorporate customers’ willingness to pay for sustainability. It is found that as long as certain assumptions are fulfilled, in both the cases there is scope for developing a more efficient pricing mechanism based on better screening for risk preferences. An attempt is made to empirically test these hypotheses on the Finnish motor insurance market, and the results seem to validate the theoretical ground work. Einav and Finkelstein’s positive correlation test is run on data provided by a Finnish insurer, and the results provide evidence in support of adverse selection in the motor insurance market. Findings from a previous study investigating Finnish motorists’ attitudes towards increased fuel prices for climate-friendly mobility policies are analysed to check for interlinkages between background characteristics and the willingness to pay for sustainability. It is found that some background characteristics affecting risk preferences in insurance markets are related to this willingness to pay. Thus, these empirical results provide preliminary evidence for there being scope for further developing these interlinkages into a more efficient pricing framework for the insurer. The proposed framework requires more serious theoretical development and empirical validation. However, even with the current findings, it makes an early contribution not just towards providing a direct economic incentive for insurers to incorporate sustainability into the core of their business operations, but also towards mitigating (at least to some extent) the age-old problem of customer selection of certain risk preferences and the resultant inefficient pricing.Description
Thesis advisor
Liski, MattiKeywords
insurance markets, customer selection, sustainability premium, price discrimination