Risk Preferences in Small and Large Stakes: Evidence from Insurance Contract Decisions

73 Pages Posted: 17 Jul 2017

See all articles by Benjamin Collier

Benjamin Collier

Temple University - Risk Management & Insurance & Actuarial Science

Howard Kunreuther

University of Pennsylvania - Operations, Information and Decisions Department; National Bureau of Economic Research (NBER)

Erwann Michel-Kerjan

University of Pennsylvania - The Wharton School - Center for Risk Management

Daniel Schwartz

University of Chile

Date Written: July 2017

Abstract

We examine risk preferences using the flood insurance decisions of over 100,000 households. In each contract, households make a small stakes decision, the deductible, and a large stakes one, the coverage limit. Over 94 percent of household choose one of the two lowest deductibles out of six options, and 77 percent fully insure, select a coverage limit of at least their home’s replacement cost. Households must be extremely risk averse to explain each of these choices with standard expected utility models. Households’ deductible choices imply a median relative risk aversion of 108. Households’ coverage limit choices require a median relative risk aversion of at least 112. Their substantial risk aversion over large stakes is due to households’ tendency to fully insure despite paying premiums well above their contracts’ expected value. Allowing for probability distortions improves our models and explains the small and large decisions of most households in our data. Assessing rank dependent utility models, we find that households follow two tenets of prospect theory: overestimation of small probabilities and diminishing sensitivity to losses.

Suggested Citation

Collier, Benjamin and Kunreuther, Howard C. and Michel-Kerjan, Erwann and Schwartz, Daniel, Risk Preferences in Small and Large Stakes: Evidence from Insurance Contract Decisions (July 2017). NBER Working Paper No. w23579. Available at SSRN: https://ssrn.com/abstract=3003717

Benjamin Collier (Contact Author)

Temple University - Risk Management & Insurance & Actuarial Science ( email )

Fox School of Business and Management
1301 Cecil B. Moore Ave.
Philadelphia, PA 19122
United States

Howard C. Kunreuther

University of Pennsylvania - Operations, Information and Decisions Department ( email )

3730 Walnut Street
558 & 559 Jon M. Huntsman Hall
Philadelphia, PA 19104-5340
United States
212-854-0423 (Phone)
215-573-2130 (Fax)

National Bureau of Economic Research (NBER)

Erwann Michel-Kerjan

University of Pennsylvania - The Wharton School - Center for Risk Management ( email )

Jon M Huntsman Hall, Suite 500
3730 Walnut Street
Philadelphia, PA 19104-6365
United States

Daniel Schwartz

University of Chile ( email )

Beauchef 851
Santiago, R. Metropolitana
Chile

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