Characterizing Households' Large (and Small) Stakes Decisions: Evidence from Flood Insurance

61 Pages Posted: 10 Jan 2020 Last revised: 6 May 2020

See all articles by Benjamin Collier

Benjamin Collier

Temple University - Risk Management & Insurance & Actuarial Science

Daniel Schwartz

University of Chile

Howard Kunreuther

University of Pennsylvania - Wharton Risk Management and Decision Processes Center; National Bureau of Economic Research (NBER)

Erwann Michel-Kerjan

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

Date Written: December 19, 2019

Abstract

We examine the flood insurance decisions of over 100,000 households, using standard expected utility models and rank dependent utility models that incorporate probability distortions. Consumers’ insurance choices provide important insights into their risk attitudes. Previous research has typically examined modest stakes choices, such as appliance warranties and deductibles, leaving important questions about larger stakes decisions. Features of U.S. flood insurance allow us to model risk attitudes over large stakes from consumers’ coverage limits. We find that consumers are typically willing to pay premiums well above the expected value of their contracts, though consumers’ decisions vary substantially over large stakes. Explaining these choices with standard expected utility models requires massive variation in risk aversion. In contrast, models incorporating probability distortions greatly improve the ability to predict households’ decisions. These models explain consumers’ choices through their overweighting of small probabilities and can more easily accommodate the observed variation in consumers’ decisions. Our large-stakes choice analyses reveal new insights on models of consumers’ risk preferences.

Keywords: Consumer choice, risk attitudes; insurance; decision making under risk and uncertainty; National Flood Insurance Program

JEL Classification: D12, D78, D81, G22, H42, Q54

Suggested Citation

Collier, Benjamin and Schwartz, Daniel and Kunreuther, Howard C. and Michel-Kerjan, Erwann, Characterizing Households' Large (and Small) Stakes Decisions: Evidence from Flood Insurance (December 19, 2019). Available at SSRN: https://ssrn.com/abstract=3506843 or http://dx.doi.org/10.2139/ssrn.3506843

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

Daniel Schwartz

University of Chile ( email )

Beauchef 851
Santiago, R. Metropolitana
Chile

Howard C. Kunreuther

University of Pennsylvania - Wharton Risk Management and Decision Processes Center ( email )

3819 Chestnut Street
Suite 130
Philadelphia, PA 19104
United States
215-898-4589 (Phone)

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

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