An Incentive‐Compatible Experiment on Probabilistic Insurance and Implications for an Insurer's Solvency Level

29 Pages Posted: 20 Feb 2018

See all articles by Anja Zimmer

Anja Zimmer

Humboldt University of Berlin - School of Business and Economics

Helmut Gründl

Goethe University Frankfurt - Department of Finance; International Center for Insurance Regulation

Christian Schade

Humboldt-Universitaet zu Berlin

Franca Glenzer

HEC Montreal - Retirement and Savings Institute

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Date Written: March 2018

Abstract

This article is the first to conduct an incentive‐compatible experiment using real monetary payoffs to test the hypothesis of probabilistic insurance, which states that willingness to pay for insurance decreases sharply in the presence of even small default probabilities as compared to a risk‐free insurance contract. In our experiment, 181 participants state their willingness to pay for insurance contracts with different levels of default risk. We find that the willingness to pay sharply decreases with increasing default risk. Our results, hence, strongly support the hypothesis of probabilistic insurance. Furthermore, we study the impact of customer reaction to default risk on an insurer's optimal solvency level using our experimentally obtained data on insurance demand. We show that an insurer should choose to be default‐free rather than having even a very small default probability. This risk strategy is also optimal when assuming substantial transaction costs for risk management activities undertaken to achieve the maximum solvency level.

Suggested Citation

Zimmer, Anja and Gründl, Helmut and Schade, Christian and Glenzer, Franca, An Incentive‐Compatible Experiment on Probabilistic Insurance and Implications for an Insurer's Solvency Level (March 2018). Journal of Risk and Insurance, Vol. 85, Issue 1, pp. 245-273, 2018. Available at SSRN: https://ssrn.com/abstract=3124657 or http://dx.doi.org/10.1111/jori.12148

Anja Zimmer (Contact Author)

Humboldt University of Berlin - School of Business and Economics ( email )

Spandauer Str. 1
Berlin, D-10099
Germany

Helmut Gründl

Goethe University Frankfurt - Department of Finance ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, Hessen 60323
Germany

HOME PAGE: http://https://www.wiwi.uni-frankfurt.de/en/departments/finance/home.html

International Center for Insurance Regulation ( email )

House of Finance
Campus Westend, Goethe University
Frankfurt am Main, D-60323
Germany

HOME PAGE: http://www.icir.de

Christian Schade

Humboldt-Universitaet zu Berlin ( email )

School of Business and Economics
Unter den Linden 6
Berlin, Berlin 10099
Germany

HOME PAGE: http://enim.wiwi.hu-berlin.de/index-en.html

Franca Glenzer

HEC Montreal - Retirement and Savings Institute ( email )

United States

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