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Behavioral bias and the demand for bicycle and flood insurance


With data from an insurer that provides coverage for both a low probability, high consequence (LPHC) risk (the flood peril) and a high probability, low consequence (HPLC) risk (bicycle theft), we investigate behavioral bias in the demand for insurance. Our analysis provides evidence which is consistent with a preference for insurance for HPLC risks over LPHC risks: we find that many more policyholders purchase add-on coverage to their homeowner’s insurance to cover the risk of bicycle theft than to cover the risk of loss due to flooding. In addition, we find mixed evidence on whether policyholders’ insurance coverage decisions are responsive to changes in their risk exposure. We find a strong relationship between wealth and the demand for both types of coverage.

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  1. The “Zoning-System for Floods, Tailback and Heavy Rain” (ZÜRS) was developed by the Association of German Insurance Companies (GDV). The system enables insurance companies to assign almost every building in Germany to one of four flood risk classes. Please refer to Section 2 for further details.

  2. For a general discussion on the interactive role of experiments and theory in analyzing insurance demand from a behavioral economics perspective, please refer to Richter et al. (2014).

  3. Insurance agents are typically compensated with commissions based on the amount of insurance sold. The agent thus has two objectives: to provide sound professional advice and to maximize compensation payments. The companies and products with the highest commissions are not necessarily the ones that best fit the needs of the policyholder. This might create an incentive for the agent not to recommend the optimal contract and insurance company (see Schiller 2011). Inderst (2011) discusses the importance of advice in the market for retail financial services. He states that advisors who are paid by commissions might not de-bias investors but rather “increase revenues through churning when customers already have a bias towards excessive trading.” However, for two reasons this should not be a problem in the case of natural hazards insurance. Premiums, at least in Germany, are not very high and thus premium based commissions will not be very high either. Consequently, agents might focus on enhancing their relationship with their customers by providing advice to customers free from consideration of their potential commission income. Secondly, commissions only give the agent an additional incentive to inform policyholders about their flood risk exposure and the option to purchase natural hazards insurance.

  4. Since we are primarily interested in individuals’ decisions, it is advantageous that our data are from a single insurer. Our analyses are free of confounding effects that would be introduced were our data from multiple insurers.

  5. Earthquakes hardly ever occur in the part of Germany where the insurer writes coverage.

  6. In 2009, 80 % of the households in Germany had at least one bicycle (see Federal Statistical Office 2009).

  7. Typically, retail property and casualty insurance contracts in Germany are automatically renewed annually if the policyholder does not lapse. As a consequence, the contracts behave similar to multi-year contracts with annual (or semi-annual) premium payment. Through direct debit, the policyholder allows the insurer to withdraw the premium from the policyholder’s bank account every time it is due without any further action required. If the policyholder opts to pay via wire transfer, she has to transfer money from her bank account to the insurer’s bank account after receiving an invoice from the insurer.

  8. We also ran our analysis including outliers and apartments. Results did not significantly change.

  9. Policies are one-year in length and renewable.

  10. P = a*(sum insured). The factor “a” in the equation is a fixed constant.

  11. The insurer’s portfolio of in force contracts in June 2010 consists of contracts from different generations. For contracts sold before 1997, policyholders could not purchase additional coverage for natural hazard risks. The insurance company completely changed the contract design for the base contracts in 2009. In doing so they also changed the pricing scheme for the natural hazards coverage. For these policies, the flood risk classification and the building type are used for risk classification (i.e., premium is higher for policyholders living in a house than for those living in an apartment and higher for those living in flood risk class 3 than for those living in flood risk class 1). This completely changes the expected effects of risk exposure on the demand for natural hazards coverage. Thus, we restrict our analysis to contracts initially sold between 1997 and 2008. When the contract design was modified in 2009, customers holding an old contract were offered the possibility to switch to the new conditions, but they did not have to. Only a few of them did. Excluding from our analysis the policyholders that switched to the new conditions might induce a sample selection bias. Our analysis suggests this potential bias does not remarkably change our results.

  12. We do not have information on the claims for the different flood risk areas, so we cannot calculate whether premiums are adequate. But the insurance company affirmed that the premium per unit of coverage was lower for the contracts in flood risk classes 2 and 3 and they were losing money with these contracts. Hence, there seems to be some cross-subsidization (i.e., those in low risk areas overpay relative to their risk and those in high risk areas underpay relative to their risk).

  13. A premium increase due to having more insured is not the same as a price increase, which is a greater cost per unit of insured value. While we do not have the true price of coverage, but rather just the premium that was paid, we expect the premium to proxy price. A flat cost per dollar of coverage coupled with a decreasing probability of loss at higher monetary amounts suggests that the insurance loading, which is the true cost of insurance, increases with the total value of premium paid.

  14. Of course, an effect of the sales channel on insurance demand could occur if policyholders who purchase through an agent differ from those who do not (for instance, regarding wealth or risk aversion). We are not aware of many studies analyzing the characteristics and behavior of policyholders between different sales channels. Bauer et al. (2002) do not find a big impact of policyholders’ socio-demographic characteristics on their propensity to purchase insurance over the internet. One exception is that individuals purchasing insurance online tend to have slightly higher incomes. Policyholders in our dataset do not remarkably differ with regard to observable characteristics between sales channels. Also, the premium policyholders have to pay does not remarkably differ between sales channels.

  15. For a more detailed description of the bivariate probit model, see Greene (1996).

  16. The preference for bicycle theft coverage over natural hazards coverage is the same if we consider only individuals living in flood risk class 2 and 3.

  17. We thank an anonymous referee for making this observation.

  18. We have no evidence that bicycle theft coverage in risk class 3 has a higher loading compared to the other two risk classes.


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Correspondence to Mark J. Browne.

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The authors are thankful for the helpful comments from an anonymous reviewer as well as from the participants at the 2011 ARIA meeting, the Munich Behavioral Insurance Workshop 2011, the 2012 EGRIE meeting and the 2012 annual meeting of the Deutscher Verein für Versicherungswissenschaft. All remaining errors are the authors’.

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Browne, M.J., Knoller, C. & Richter, A. Behavioral bias and the demand for bicycle and flood insurance. J Risk Uncertain 50, 141–160 (2015).

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  • Decision making under risk
  • Risk assessment
  • Insurance demand

JEL Classifications

  • D81
  • D83
  • D84