Challenges in the Era of Globalization - iaabd

Proceedings of the 12th Annual Conference © 2011 IAABD
Theoretical Perspectives
A theory is a body of logically interdependent and generalized concepts of empirical reference (Parsons,
1964). This also refers to abstractions, speculations, ideas and conceptual constructions which are
tentative and attempt to make a causal explanation or descriptive illustration of a particular phenomenon.
Theory of Consumer Behaviour
The traditional theory of consumer behavior assumed that the consumer or decision maker is certain of
the outcomes arising from alternative acts or decisions. However, many choices made by consumers take
place under conditions of uncertainty. In this section, we explore how the theory of consumer choice can
be used to describe such behavior following the path breaking work of Neumann and Morgestern (1944).
Suppose a consumer initially has monetary wealth W. There is some probability p that he will lose an
amount L. For instance, there is some probability his house will burn down. The consumer can purchase
insurance that will pay him q naira in the event that he incurs this loss. The amount of money that he has
to pay for q naira of insurance coverage is πq; while π is the premium per naira of coverage.
Thus this situation can be characterized as a game of chance as follows:
(W – L – πq + q, W – πq), (p,1-p)…………………………………………………………………………….1
If we consider a special scenario of this lottery, where he fully insures risk; i.e., where q = L. With full
insurance, state contingent wealth is W – πq regardless of whether a state contingent loss occurs; thus he
exchanges an uncertain loss (L) for a certain loss (πq).
We assume that this individual has a von Neumann-Morgenstern utility function U(W). Thus U(W) is
continuous and twice differentiable; i.e., marginal utility is positive and decreasing in wealth. Given these
assumptions, insurance will be purchased if and only if a q exists such that the expected utility of being
insured is higher than the expected utility of being uninsured; i.e.,
pU(W – πq – L + q) + (1 – p)U(W - πq > pU(W - L) + (1 – p)U(W)…………………………………2
How much coverage will the consumer purchase can be analyzed by solving the utility maximization
problem thus:
max E(U(W))= Max pU(W – L – πq + q) + (1 – p)U(W – πq)……………………………………….3
The solution to this maximization problem (among other factors) depends on the attitude of the individual
to risk. If the consumer is strictly risk averse he will completely insure himself against the loss L. A
person is a risk averter relative to a lottery if the utility of its expected value is greater than the expected
value of its utility. Such a person prefers a certain outcome to an uncertain one with the same expected
value. On the other hand a person can be risk neutral relative to a lottery if the utility of the expected
value of the lottery equals the expected utility of the lottery. Such a person is only interested in expected
values and is totally oblivious to risk. In the same vein, a person can be a risk lover relative to a lottery if
the utility of its expected value is less than its expected utility. However, sociologists have offered
different theoretical explanations for this attitudinal behavior.
Socio-cultural School
One theory that informs people attitude towards insurance is the social action. The social action theory by
Max Weber explains that human actions are meaningful and that certain reasons push people into various
kinds of actions. To Weber, there are three kinds of action: traditional (based on customs and habits);
affective (based on the emotional state of the individual at a particular time); and rational (based on a
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