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Dynamic Insurance Decision-Making for Rare Events: The Role of Emotions

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Abstract

This paper describes the results of a web-based experiment that uses respondents’ stated preferences for purchasing insurance for low-probability, high-consequence events where the probability of a loss and its consequences are stable over time. We contrast the predictions of a model of insurance choice based on expected utility [E(U)] maximisation with those of an alternative behavioural model. The majority of subjects reported insurance purchasing behaviour consistent with expected utility theory; however, a sizeable number of uninsured individuals decided to purchase insurance after learning that they had suffered a loss whereby they responded that their prior choice to be uninsured made them unhappy. In this sense, the study shows that a loss coupled with self-reported emotions linked to the loss is likely to play an important role in convincing some uninsured persons to buy coverage. In contrast, insured individuals who did not suffer a loss rarely dropped coverage.

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Notes

  1. Kunreuther et al. (2013), Chs. 6 and 7.

  2. Neipp and Zeckhauser (1985); Madrian and Shea (2001).

  3. Michel-Kerjan et al. (2012).

  4. Kunreuther et al. (2013).

  5. Gul and Pesendorfer (2007).

  6. Koszegi and Rabin (2007).

  7. Bernheim and Rangel (2009).

  8. Einav et al. (2012).

  9. We assume that there are no effects on insurance purchasing decisions from changes in wealth as a function of loss experience. In a previous experiment on the role of affect on willingness to pay for insurance, Hsee and Kunreuther (2000) provide support for this assumption.

  10. Jaspersen (2016).

  11. Hershey and Schoemaker (1980); Lypny (1993); Fehr-Duda et al. (2006); Kusev et al. (2009).

  12. Loewenstein et al. (2001); Finucane et al. (2000).

  13. Hsee and Kunreuther (2000).

  14. Bell (1982); Loomes and Sugden (1982); Braun and Muermann (2004).

  15. We also asked respondents how GLAD they were with their insurance choice before they knew whether or not a loss had occurred. Beyond the obvious finding that they were happier when they paid a low premium, this variable did not predict insurance choice or change in insurance status over time.

  16. Wagenaar and Keren (1988).

  17. An analysis of the data indicates that the tutorial had no significant impact on the insurance purchase decision. A graphic photo of damage from a hurricane in period 5 tended to increase insurance demand in that period.

  18. Oppenheimer et al. (2009).

  19. There were 40 participants who chose to STAY UNINSURED when premiums were unfair, which is 3 per cent of the 1,346 participants.

  20. We constructed this dichotomous variable for FEEL after determining that there were no significant differences in switching behaviour between those who expressed a FEEL of 0 or 1 and those who expressed a FEEL of 3, 4 and 5.

  21. This difference is not exhibited in period 2, where only 17 per cent of the uninsured individuals in period 2 had purchased insurance in period 1 compared to 54 per cent who had coverage at least once during periods 1 through 7.

  22. In examining switching behaviour between periods 2 and 8 for those who did and did not suffer a loss, we see from Table 4 that there is no statistically significant difference.

  23. We cannot rule out the possibility of reverse causation here where deciding to switch for some other reason prompts one to report low FEEL.

  24. Bottom et al. (2002).

  25. Lount et al. (2008).

  26. We do not investigate the uninsured who did not suffer a loss since almost all of them have high values of FEEL as shown in Table 3.

  27. Kunreuther et al. (1978).

  28. The only group approaching statistical significance was the ALWAYS INSURED in period 2. Those who did not experience a loss in periods 1 and 2 were more likely to switch to being uninsured than those did suffer a loss, behaviour that is consistent with individuals treating insurance as an investment rather than a form of protection.

  29. Gilovich and Medvec (1995).

  30. Bernheim and Rangel (2009).

  31. For more details on intuitive and deliberative thinking see Kahneman (2011).

  32. Thaler and Sunstein (2008).

  33. Shiller (2003).

  34. Meyer and Kunreuther (2017)

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Acknowledgements

The authors thank the referees for helpful feedback on this paper. Sergeant Shriver and John Sperger provided excellent research assistance. Support for this research comes from the Travelers-Wharton Partnership for Risk Management Fund, the Center for Risk and Economic Analysis of Terrorism Events (CREATE) at the University of Southern California, the Zurich Insurance Foundation, and the Wharton Risk Management and Decision Processes Center project on “Managing and Financing Extreme Events.”

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Authors and Affiliations

  1. Department of Operations, Information and Decisions, The Wharton School, University of Pennsylvania, 3730 Walnut Street, 563 Jon M. Huntsman Hall, Philadelphia, PA, 19104, USA

    Howard Kunreuther

  2. Department of Health Care Management, The Wharton School, University of Pennsylvania, 208 Colonial Penn Center, 3641 Locust Walk, Philadelphia, PA, 19104, USA

    Mark V. Pauly

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Correspondence to Howard Kunreuther.

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Kunreuther, H., Pauly, M.V. Dynamic Insurance Decision-Making for Rare Events: The Role of Emotions. Geneva Pap Risk Insur Issues Pract 43, 335–355 (2018). https://doi.org/10.1057/s41288-017-0068-x

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