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Probabilistic insurance

Author

Listed:
  • Wakker, P.P.

    (Tilburg University, Center For Economic Research)

  • Thaler, R.H.
  • Tversky, A.

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. Copyright 1997 by Kluwer Academic Publishers
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Suggested Citation

  • Wakker, P.P. & Thaler, R.H. & Tversky, A., 1997. "Probabilistic insurance," Discussion Paper 1997-35, Tilburg University, Center for Economic Research.
    • Handle: RePEc:tiu:tiucen:7532d1e7-187b-4418-95a1-95b199f83474
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    References listed on IDEAS

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    1. R. Duncan Luce & Detlof von Winterfeldt, 1994. "What Common Ground Exists for Descriptive, Prescriptive, and Normative Utility Theories?," Management Science, INFORMS, vol. 40(2), pages 263-279, February.
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    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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