Return freight insurance strategies for the online retailer and insurance company

Abstract

In online purchases, customers often exhibit considerable hesitations due to quality uncertainty and return freight fees. In response, online retailers may buy the return freight insurance (RFI) service from insurance companies that compensate the customers when they return the purchased item. With the RFI service, insurance companies generally verify the quality information posted by the retailer to avoid excessive customer returns. Thus, the RFI service not only reduces the customer’s return freight but also acts as an imperfect quality signal for customers to mitigate quality uncertainty. We characterize the RFI’s imperfect signaling effect by signal efficiency, and develop a game-theoretic model to investigate the RFI strategies of insurance companies and the retailer. Our results shed light on how signal efficiency and return freight fees drive their RFI strategies. The insurance companies charge an extremely small RFI premium for the retailer selling high-quality products; for the retailer selling low-quality products, the RFI premium becomes large for those with a medium return freight fee, or with a small signal efficiency. The retailer selling high-quality products always adopts the RFI service. The retailer selling low-quality products does not adopt the RFI service when the return freight fee is large. Given a medium return freight fee, the retailer with low-quality products prefers the RFI service when the signal efficiency is medium. Given a small return freight fee, only when the signal efficiency is large does the retailer with low-quality products adopt the RFI service. Our results provide new explanations for the prevalence of the RFI service for retailers selling products of different quality, and shed light on the RFI premium strategy for insurance companies.