This paper generated a lively discussion among many of the conference participants. Howard Kunreuther of the Wharton School opened the discussion by calling for a broader view of errors in judgment within the demand and supply framework when dissecting reasons for the divergence between insurance theory and practice. On the demand side, consumers seem to view insurance as an investment rather than a contingent claim. This view creates a strong preference for low deductibles and rebate schemes so that the insured can "get something back." Also on the demand side, paying a premium over and above the expected value is rational for consumers who derive peace of mind from the risk transfer. On the supply side, only a principal agent problem or some ambiguity in coverage can explain the decision not to offer coverage at a certain premium.
Insurers buying reinsurance share the view of insurance as an investment. Joan Lamm-Tennant of the General Reinsurance Corporation criticized insurance companies for focusing on margins rather than volatility issues when they buy reinsurance at dangerously low attachments. Seeing combined ratios on their net business worse than those on their gross business, insurers should realize that reinsurers do charge a margin for their capital.
Scott Harrington of the University of South Carolina asserted that there is less evidence than intuition refuting rational models of how insurance markets work. Low deductibles operate as effectively higher claims thresholds than their nominal values since the insured does not generally make claims for small losses, fearing future rate increases or even cancellation of their policy. On the supply side, high uncertainty requires significant capital to preserve franchise value. This leads to higher tax and agency costs, [End Page 48] which in turn raise the supply price of insurance. This can help to explain a lack of transactions in certain markets. Alex Muermann followed up with further comment on the disutility of regret as an explanation for otherwise irrational behavior, which would explain why consumers buy seemingly expensive warranties for inexpensive electronics products.
Jim Ament of State Farm suggested that even though consumers and suppliers may be acting rationally, their behavior may be confounded by third-party constraints. Lenders wanting to protect their collateral and federal examiners seeking to maintain banking stability both effectively impose caps on maximum deductibles.
Patricia Danzon offered two explanations for the anomalies of Medigap coverage. First, the law of one price only applies in a market of truly homogeneous risk, which does not characterize this market. Second, Medigap coverage for the coinsurance and deductibles of Medicare creates the moral hazard of overuse, a cost that is passed on to Medicare.
Zeckhauser responded by reiterating that his paper was about discrepancies between elementary economic analysis and observed practice. He urged a reevaluation of current rational theories to include backward reflection and future contemplation. Normative theory should incorporate these tendencies if consumers do seek to minimize regret and anxiety. For the future, an examination of how best to disentangle and define more clearly the public and private role in government would serve the industry well. Ensuring transparency and preserving some vestige of private provision of insurance, if only as a guideline for pricing, are both critical in framing a market in which the government is the primary supplier.