Uncertainty and Welfare in Insurance Markets
48 Pages Posted: 15 Apr 2023
Technological advances in the insurance industry mean that insurers now may be better informed about underlying risks faced by individual consumers than consumers themselves. We evaluate the impact of these information frictions on welfare by combining demand elicitation surveys with insurance claim data. As expected, we find an ‘uncertainty premium’ -i.e., consumers are willing to pay more for insurance when risks are uncertain. Interestingly, we find that the uncertainty premium is negatively correlated with risk aversion at all sizes and probabilities of risks. This leads to a selection effect: individuals who purchase insurance are not necessarily the most risk averse. We show that the resulting misallocation of insurance leads to large welfare losses.
Keywords: D12, D14, D81, G22, J33
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