Insurance decisions for low-probability losses

It is widely accepted that individuals tend to underinsure against low-probability, high-loss events relative to high-probability, low-loss events. This conventional wisdom is based largely on field studies, as there is very little experimental evidence. We reexamine this issue with an experiment that accounts for possible confounds in prior insurance experiments. Our results are counter to the prior experimental evidence, as we observe subjects buying more insurance for lower-probability events than for higher-probability events, given a constant expected loss and load factor. Insofar as underinsurance for catastrophic risk is observed in the field, our results suggest that this can be attributed to factors other than only the relative probability of the loss events.

J. Todd SwarthoutEmail: