State Aggregation in Insurance Choices

Optimizing utility in all states of the world at once might be difficult even for a machine. This paper adds to the behavioral literature by testing models in which the agent aggregates the states together, even though he or she is aware of the entire state space. Different ways of framing objective information may cause agents to aggregate states in predictable ways, which also has a predictable effect on their decisions. Our findings from an experiment suggest the participants respond to the above framing manipulations when asked to choose insurance plans. In addition, the subjects demonstrate event-loving – the desire to make more similar choices in aggregated states. This finding should not be confused with risk aversion, because such behavior is triggered by the aggregation-inducing frame rather than the natural desire to lower the uncertainty. Our results explain why agencies such as insurance companies use heuristics and the innate confusing nature of contracts to engage consumers in choices that are profitable only for the supplier.