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The effect of precommitment and past-experience on insurance choices : an experimental study

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Abstract

This paper reports results from an experimental study that investigates insurance behaviours in low-probability high-loss risk situations. This study reveals that insurance behaviours may depend on the individual prior experience towards risk. It may also depend on the duration of the commitment period, namely the period during which individuals commit themselves to maintain the same insurance decision. Non-additive decision models such as Dual Theory and Cumulative Prospect Theory seem to have a higher descriptive power than Expected Utility Theory when explaining subjects' behaviours. This paper presents a direct experimental test of the prediction of Myopic Prospect Theory relative to insurance demand. This study is also designed to test the significance of gambler's fallacy and availability bias in the insurance decision process. These theoretical concepts help to understand many behaviours commonly observed in reality but which remain unexplained within the E.U framework. In particular, this paper provides new explanations about the puzzling fact that people usually fail to obtain insurance against disaster-type risks such as natural disasters, even when premiums are close to actuarially fair levels. According to our experimental results, the deficiency of insurance demand for natural disasters may be due to the lack of individual prior experience towards such risks ; as well as the relatively short commitment period of insurance policies (usually one fiscal year) compared with the empirical frequency of major natural hazards (centennial and even more).

Suggested Citation

  • Thomas Papon, 2004. "The effect of precommitment and past-experience on insurance choices : an experimental study," Cahiers de la Maison des Sciences Economiques b04083, Université Panthéon-Sorbonne (Paris 1).
  • Handle: RePEc:mse:wpsorb:b04083
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    Keywords

    Insurance demand; Low-probability high-consequence risks; heuristics and bias in risk perception; experimental methodology; Cumulative Prospect Theory; Dual Theory.;

    JEL classification:

    • C90 - Mathematical and Quantitative Methods - - Design of Experiments - - - General
    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • D1 - Microeconomics - - Household Behavior
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • M31 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Marketing and Advertising - - - Marketing

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