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Probabilistic Insurance
Authors:WAKKER  PETER  THALER  RICHARD  TVERSKY  AMOS
Institution:1. CentER, Tilburg University, Tilburg, The Netherlands
2. Medical Decision Making Unit, Leiden University, Leiden, The Netherlands
3. Graduate School of Business, University of Chicago, Chicago, IL, 60637, USA
4. National Bureau of Economic Research, Cambridge, MA, 02139
5. Stanford University, Stanford, CA, 94305
Abstract:Probabilistic insurance is an insurance policy involving a small probability that the consumer will not be reimbursed. Survey data suggest that people dislike probabilistic insurance and demand more than a 20% reduction in the premium to compensate for a 1% default risk. While these preferences are intuitively appealing they are difficult to reconcile with expected utility theory. Under highly plausible assumptions about the utility function, willingness to pay for probabilistic insurance should be very close to willingness to pay for standard insurance less the default risk. However, the reluctance to buy probabilistic insurance is predicted by the weighting function of prospect theory. This finding highlights the potential role of the weighting function to explain insurance.
Keywords:
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