Risk, Ambiguity, Insurance, and the Winner's Curse1 (original) (raw)
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Theory and Decision, 2007
This article presents the results of a survey designed to test, with economically sophisticated participants, Ellsberg's ambiguity aversion hypothesis, and Smithson's conflict aversion hypothesis. Based on an original sample of 78 professional actuaries (all members of the French Institute of Actuaries), this article provides empirical evidence that ambiguity (i.e. uncertainty about the probability) affect insurers' decision on pricing insurance. It first reveals that premiums are significantly higher for risks when there is ambiguity regarding the probability of the loss. Second, it shows that insurers are sensitive to sources of ambiguity. The participants indeed, charged a higher premium when ambiguity came from conflict and disagreement regarding the probability of the loss than when ambiguity came from imprecision (imprecise forecast about the probability of the loss). This research thus documents the presence of both ambiguity aversion and conflict aversion in the field of insurance, and discuses economic and psychological rationales for the observed behaviours.
The valuation of insurance under uncertainty: does information about probability matter?
The GENEVA Papers on Risk and Insurance- …, 2001
In a laboratory experiment we test the hypothesis that consumers' valuation of insurance is sensitive to the amount of information available on the probability of a potential loss. In order to test this hypothesis we simulate a market in which we elicit individuals' willingness to pay to insure against a loss characterised either by known or else vague probabilities. We use two distinct treatments by providing subjects with different information over the vague probabilities of loss. In general we find that uncertainty about probabilities has a weak impact on consumers' valuation of insurance. However, additional information about probabilities tends to marginally increase the price individuals are willing to pay to insure themselves. Implications for the insurance market are derived.
2011
This paper reports the results of the first experiment in the United States designed to distinguish between two sources of ambiguity: imprecise ambiguity (expert groups agree on a range of probability, but not on any point estimate) versus conflict ambiguity (each expert group provides a precise probability estimate which differs from one group to another). The specific context is whether risk professionals (here, insurers) behave differently under risk (when probability is well-specified) and different types of ambiguity in pricing catastrophic risks (floods and hurricanes) and non-catastrophic risks (house fires). The data show that insurers charge higher premiums when faced with ambiguity than when the probability of a loss is well specified (risk). Furthermore, they tend to charge more for conflict ambiguity than imprecise ambiguity for flood and hurricane hazards, but less in the case of fire. The source of ambiguity also impacts causal inferences insurers make to reduce their ...
Underwriting and Ambiguity: An Economic Analysis
A simplified financial-economic theory of the insurance firm under uncertainty is used to determine whether ambiguity about the expected claim frequency and/or the claim severity distribution for potential insured losses has any impact on the insurance rate. The model shows that the risk charge for ambiguity in both the claim frequency and claim severity distributions is higher than the risk charge for ambiguity in either the claim frequency or claim severity distribution alone. Our theoretical results are consistent with underwriters’ decisions and provide a more complete analysis of the insurance premium setting process than prior research.
Journal of Risk and Uncertainty, 2011
This paper reports the results of the first experiment in the United States designed to distinguish between two sources of ambiguity: imprecise ambiguity (expert groups agree on a range of probability, but not on any point estimate) versus conflict ambiguity (each expert group provides a precise probability estimate which differs from one group to another). The specific context is whether risk professionals (here, insurers) behave differently under risk (when probability is well-specified) and different types of ambiguity in pricing catastrophic risks (floods and hurricanes) and non-catastrophic risks (house fires). The data show that insurers charge higher premiums when faced with ambiguity than when the probability of a loss is well specified (risk). Furthermore, they tend to charge more for conflict ambiguity than imprecise ambiguity for flood and hurricane hazards, but less in the case of fire. The source of ambiguity also impacts causal inferences insurers make to reduce their uncertainty.
The effect of ambiguity on risk management choices: An experimental study
Journal of Risk and Uncertainty, 2015
We introduce a model of the decision between precaution and insurance under an ambiguous probability of loss and employ a novel experimental design to test its predictions. Our experimental results show that the likelihood of insurance purchase increases with ambiguous increases in the probability of loss. When insurance is unavailable, individuals invest more in precaution when the probability of loss is known than when it is ambiguous. Our results suggest that sources of ambiguity surrounding liability losses may explain the documented tendency to overinsure against liability rather than meet a standard of care through precaution. The results provide support for our theoretical predictions related to risk management decisions under alternative probabilities of loss and information conditions, and have implications for liability, environmental, and catastrophe insurance markets. Keywords Liability. Imperfect information. Design of experiments. Laboratory experiments JEL Classifications K130. D81. C9. C920 Two apparently conflicting puzzles consistently arise out of the empirical observation of insurance markets. Both involve a tendency to make suboptimal insurance decisions and have important implications for environmental risk mitigation, consumer decision making, public finance, and firm profit maximization. First, there is substantial evidence that individuals and businesses underinsure catastrophe risk (Kunreuther and
2012
This paper investigates how the general public behaves when confronted with low probability events and ambiguity in an insurance context. It reports the results of a questionnaire completed by a large representative sample of the French population that aims at separating attitudes toward risk, imprecision and conict and at determining if there is a demand for ambiguous and extreme event risks. The data show a strong distinction between two aspects of the problem: the decision of purchasing insurance and the willingness to pay. In the decision to insure, more than 25% of the respondents refuse to buy insurance and people are more willing to insure in a risky situation than in an ambiguous one. This certain taste for risk can be explained by the respondents' observable characteristics. In addition, it highlights a lack of condence in the insurance markets. When it comes to willingness to pay, people exhibit ambiguity seeking behaviors. They are willing to pay more under risk than under ambiguity (embracing here imprecision and conict), revealing that people consider ambiguous situations as inferior. Furthermore, respondents behave dierently under imprecision and conict. They exhibit a preference for consensual information and dislike conicts. However, the willingness to pay is poorly correlated with observable characteristics.