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Risk awareness and adverse selection in catastrophe insurance: Evidence from California’s residential earthquake insurance market

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  • Xiao Lin

    (St. John’s University)

Abstract

How does catastrophe-risk awareness affect purchase decisions and selection patterns in the insurance market? I study this issue using data on take-up rates of earthquake insurance among homeowners in California, where a semi-public insurer coexists with private insurers. The public insurance policy charges cross-subsidized premiums and is offered through specific homeowners insurance agents. I find that for those offered the public earthquake policy, a positive demand-risk correlation exists within the insurer’s pricing territory, suggesting that people have some meaningful awareness of their risk and act on it in ways consistent with adverse selection. However, despite private insurers having the opportunity to select the lower risks by pricing at a finer level, the positive demand-risk correlation persists for them. I interpret this as a result of market friction that limits homeowners’ ability to comparison shop, and their relative insensitivity to price as compared to risk.

Suggested Citation

  • Xiao Lin, 2020. "Risk awareness and adverse selection in catastrophe insurance: Evidence from California’s residential earthquake insurance market," Journal of Risk and Uncertainty, Springer, vol. 61(1), pages 43-65, August.
    • Handle: RePEc:kap:jrisku:v:61:y:2020:i:1:d:10.1007_s11166-020-09335-4
    DOI: 10.1007/s11166-020-09335-4
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    2. Fabrizio Terenzio Gizzi & Donatella Porrini & Francesco De Masi, 2021. "Building a Natural Hazard Insurance System (NHIS): The Long-lasting Italian Case," Sustainability, MDPI, vol. 13(21), pages 1-22, November.
    3. Muhsin Tamturk & Dominic Cortis & Mark Farrell, 2020. "Examining the Effects of Gradual Catastrophes on Capital Modelling and the Solvency of Insurers: The Case of COVID-19," Risks, MDPI, vol. 8(4), pages 1-13, December.

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    More about this item

    Keywords

    Risk awareness; Adverse selection; Catastrophe insurance; Earthquake risk classification; Market friction; Price sensitivity;
    All these keywords.

    JEL classification:

    • D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • H00 - Public Economics - - General - - - General

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