Perceived risk and insurance decision taking for small losses (original) (raw)
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SSRN Electronic Journal, 2013
The purpose of this paper is to examine whether people treat all forms of uncertainty in the same way. Studies investigating known-risk gambles and ambiguous gambles have systematically used the urn context. Little systematic research has investigated differences in expressed attitude as a function of the manner in which vague probability information is communicated to a decision maker. The experiments reported in this paper examine the behavior of people when faced with different situations with and without an insurance context: a risky situation (the probability of loss is known), an uncertain situation (there is no prior information on the probability of loss) or an ambiguous (the information provided is vague).
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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
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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.
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