Insurance decisions with “Probable Small Probabilities”: The role of Framing and Incentives under Risk and Ambiguity.

Rocco Caferra, Andrea Morone and John Hey

Abstract: This paper considers a situation where a decision-maker (DM) is faced with the decision whether and how much to insure against a bad event which may occur sometime during a T-period horizon. If it occurs at any time during this period, the DM loses everything, unless he/she is insured. Now, whether the DM is given the information that the event may occur in any one period with probability p, or given the information that it may occur sometime during the T periods with probability P, then if P = 1−(1−p)^T, the insurance decision should be the same; the only difference is the framing of the information. However, numerous studies have shown that framing may affect decision-making. We investigate experimentally whether this is the case in this particular context. We find that framing does matter. We also investigate whether incentivisation affects the decision, by running two different treatments, one with incentives and one without. It is clear from our results that incentives matter, though in an unexpected way.

JEL Classification: G22, C91, D81

Keywords: Insurance; Choice under uncertainty; Ambiguity; Risk; Ambiguity Box; Large Probabilities; Equivalent Small Probabilities; Incentivisation; Framing.

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