ABSTRACT. A series of studies examines whether certain biases in probability assessments and perceptions of loss, previously found in experimental studies, affect consumers' decisions about insurance. Framing manipulations lead the consumers studied here to make hypothetical insurance-purchase choices that violate basic laws of probability and value. Subjects exhibit distortions in their perception of risk and framing effects in evaluating premiums and benefits. Illustrations from insurance markets suggest that the same effects occur when consumers make actual insurance purchases.
KEY WORDS insurance decisions, biases, probability distortions, framing
Insurance purchases form the basis for an extraordinarily large industry. The industry has assets of $1.6 trillion and employs over 2 million people (Insurance Information Institute, 1990a). Consumers are responsible for a significant proportion of this market, either directly through their own purchase decisions, or indirectly through their choices of employers, mortgages, etc. These investments are sizable and commonplace. For example, the average insured household carries over $100,000 of life insurance, and surveys reveal that 70% of all households report having property insurance. Insurance represents, perhaps, the most significant tool for managing financial risks available to individuals.
The last decade has seen the advent of an “insurance crisis” in the U.S. and several other countries. With respect to liability insurance, for example, there have been large increases in premiums and vanishing coverage for some risks, factors that present major problems for businesses, professionals, and consumers (Committee for Economic Development, 1989).