Complimentary Return-Freight Insurance Serves as Quality Signal or Noise?

In order to decrease the consumer return transaction cost, e-commerce platform Alibaba invited an insurance company to develop a new type of insurance to compensate consumers for returns, which is called return-freight insurance. The new insurance has resulted in online return's explosive growth. However, some online retailers still choose to offer complimentary return-freight insurance to signal their products' quality. Using signaling theory, we build a conceptual economic model to explore what kind of online retailer should adopt this strategy under incomplete information. Based on the fact that each product's return probability, profit, and insurance compensation are different, our main results show the separating equilibria, where only high-quality online retailers will offer complimentary return-freight insurance. Interestingly, return-freight insurance profit and compensation play different roles in the signal effect. The insurance premium plays a deep role while the compensation plays at the surface, because consumers could only observe the compensation when purchasing.