Risk reduction in compulsory disaster insurance: Experimental evidence on moral hazard and financial incentives

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Abstract

In a world in which economic losses due to natural disasters are set to increase, it is essential to study risk reduction strategies, including individual homeowner investments in damage-reducing (mitigation) measures. In this lab experiment (N = 357), we investigated the effects of different financial incentives, probability
levels, and deductibles on self-insurance investments in a natural disaster insurance market with compulsory coverage. In particular, we examined how these investments are jointly influenced by financial incentives, such as insurance, premium discounts, and mitigation loans. We also studied the influence of behavioral characteristics, including individual time and risk preferences. We found that investments increase when the expected value of the damage increases (i.e., higher deductibles, higher probabilities). Moral hazard is found in the high-probability (15%) scenarios, but not in the low-probability (3%) scenarios. This suggests that moral hazard is less of an issue in an insurance market where probabilities are low. Our results demonstrate that a premium discount can increase investment in damage-reduction, as can a policyholder‘s risk aversion, perceived efficacy of protective measures, and worry about flooding.
Original languageEnglish
Article number101500
Pages (from-to)1-58
JournalJournal of Behavioral and Experimental Economics
Volume84
Early online date2 Dec 2019
DOIs
Publication statusPublished - 1 Feb 2020

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Disasters
Risk Reduction Behavior
Insurance
insurance
Motivation
disaster
incentive
Deductibles and Coinsurance
deductible
damages
evidence
premium
natural disaster
insured person
scenario
homeowner
market
loan
coverage
Economics

Keywords

  • Behavioral insurance
  • Moral hazard
  • Lab experiment
  • Natural disasters
  • Damage-reduction measures

Cite this

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title = "Risk reduction in compulsory disaster insurance: Experimental evidence on moral hazard and financial incentives",
abstract = "In a world in which economic losses due to natural disasters are set to increase, it is essential to study risk reduction strategies, including individual homeowner investments in damage-reducing (mitigation) measures. In this lab experiment (N = 357), we investigated the effects of different financial incentives, probabilitylevels, and deductibles on self-insurance investments in a natural disaster insurance market with compulsory coverage. In particular, we examined how these investments are jointly influenced by financial incentives, such as insurance, premium discounts, and mitigation loans. We also studied the influence of behavioral characteristics, including individual time and risk preferences. We found that investments increase when the expected value of the damage increases (i.e., higher deductibles, higher probabilities). Moral hazard is found in the high-probability (15{\%}) scenarios, but not in the low-probability (3{\%}) scenarios. This suggests that moral hazard is less of an issue in an insurance market where probabilities are low. Our results demonstrate that a premium discount can increase investment in damage-reduction, as can a policyholder‘s risk aversion, perceived efficacy of protective measures, and worry about flooding.",
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