The Economics of Return Insurance

This study examines the return strategies of competitive online sellers, considering three strategies: no insurance, return insurance, and free returns. Risk-averse consumers purchase products if they match their preferences, but decide whether to return them if they do not. Consumers are assumed to be identical except for their preferences and exchange costs. The analysis yields the following results. First, offering return insurance or free returns is superior to no insurance. This is due to consumers' risk aversion. Second, the proportion of consumers returning products increases in the order of no insurance, return insurance, and free returns. This is because purchasing insurance leads to lower return costs. Third, when sellers can choose return strategies, in equilibrium, (i) all three strategies coexist, (ii) only return insurance exist, or (iii) only no insurance and free returns coexist.