An economic decision-making approach to estimate the value for money of non-IBIPs insurance contracts

The POG (Product Oversight and Governance) discipline in the insurance sector has directed the attention of supervisory authorities toward “value for money,” understood as the relationship between the price paid by the insured and the benefits obtained from the policy, including the quality of the service offered by the insurer and the guarantees provided by the policy itself. An insurance policy that respects the principle of value for money should offer coverage tailored to the customer’s needs, a competitive price compared to other options on the market, and high-quality customer service. While, with reference to IBIPs (Insurance-Based Investment Products), EIOPA (European Insurance and Occupational Pensions Authority) has recently published a methodological document for the evaluation of “value for money,” the market of non-IBIP (as non-investment based insurance contract) products has not yet been adequately investigated. The aim of this work is to propose a quantitative solution to the problem of measuring the “value for money” for the insured of non-IBIP products. We adopt an algorithm based on the expected utility theory introduced by von Neumann and Morgenstern (Theory of Games and Economic Behavior. Princeton University Press, 1944), which we extend with a percentile-based approach in order to take into account a general loss probability distribution with high asymmetry and kurtosis. Using the elements of this model, we represent how a potential insured can evaluate the fairness of an insurance contract, consistent with his or her particular psychological predisposition toward risk. The approach is then extended to non-IBIP life insurance contracts (life insurance contract to cover only death risk), allowing for the evaluation of products that bundle different life and non-life guarantees (such as credit protection insurance policies (CPI). Finally, we present an implementation of the proposed algorithm in a Visual Basic for Applications (VBA) tool for insurers to routinely check value for money (VfM) for their product. We illustrate an application to a composite product and estimate an efficient frontier (iso-utility frontier) that accounts for different levels of individual risk tolerance.