Boundedly Rational Expectations in Insurance Decision Making: Experimental and Field Evidence

Abstract

We examine a type of behavioral regularities in insurance decision making, namely instances when consumers do not fully take into account the informational value of the insurer’s offered premium. Specifically, we study scenarios when the consumer is less informed about the loss probability than the insurer. We examine basic violations of rational expectations, with which the consumer overestimates the loss probability beyond what could be inferred from the premise that the insurer must seek to break even or earn a profit over the risk to be covered. We report a field study and an experiment that reveal systematic occurrence of such violations. Violations were especially frequent at low premium levels, and the demand for insurance had an inverted-U dependence on the premium. Our findings suggest that, when consumers form beliefs over the loss probability, they take into account the offered premium to some extent, but often insufficiently so.

Keywords: insurance, rational expectations, cursedness, bounded rationality, behavioral economics

JEL Classification: D03, G22, C90