On the Preference for Full-Coverage Policies: Why do People Buy Too Much Insurance?

28 Pages Posted: 2 Nov 2007

See all articles by Zur Shapira

Zur Shapira

Leonard N. Stern School of Business - Department of Economics; New York University (NYU) - Department of Management and Organizational Behavior

Itzhak Venezia

Hebrew University of Jerusalem - Jerusalem School of Business Administration

Abstract

One of the most intriguing questions in insurance is the preference of consumers for low or zero deductible insurance policies. This stands in sharp contrast to a theorem proved by Mossin, 1968, that under quite common assumptions when the price of insurance is higher than its actuarial value, then full coverage is not optimal.

We show in a series of experiments that amateur subjects tend to underestimate the value of a policy with a deductible and that the degree of underestimation increases with the size of the deductible. We hypothesize that this tendency is caused by the anchoring heuristic. In particular, in pricing a policy with a deductible subjects first consider the price of a full coverage policy. Then they anchor on the size of the deductible and subtract it from the price of the full coverage policy. However, they do not adjust the price enough upward to take into account the fact that there is only a small chance that the deductible will be applied toward their payments. We also show that professionals in the field of insurance are less prone to such a bias. This implies that a policy with a deductible priced according to the true expected payments may seem "overpriced" to the insured and therefore may not be purchased. Since the values of full coverage policies are not underestimated the insured may find them as relatively better "deals".

Keywords: Anchoring, discounting, insurance, decision making, premium

JEL Classification: G10, G22, C9, D1, D81

Suggested Citation

Shapira, Zur and Venezia, Itzhak, On the Preference for Full-Coverage Policies: Why do People Buy Too Much Insurance?. Journal of Economic Psychology, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1026085

Zur Shapira (Contact Author)

Leonard N. Stern School of Business - Department of Economics ( email )

40 West Fourth Street, 7-06
New York, NY 10012
United States

New York University (NYU) - Department of Management and Organizational Behavior ( email )

44 West 4th Street
New York, NY 10012
United States

Itzhak Venezia

Hebrew University of Jerusalem - Jerusalem School of Business Administration ( email )

Mount Scopus
Jerusalem, 91905
Israel

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