Optimism, Overconfidence, and Insurance Decisions

We report experimental evidence regarding the effects of overconfidence and optimism on insurance decisions. The novel experimental design elicits risk perception information from participants prior to their participation in an incentivized risk management and insurance task. Our design distinguishes between an individual's optimism bias and overconfidence bias, a contribution that is particularly important for analysis of insurance decisions related to risks outside of the purchaser's control. Our results show that, after controlling for risk-seeking behavior, optimistic participants incur a higher total cost of risk and are more likely to underinsure than non-optimistic participants, even in cases where the purchase of insurance provides the highest expected payoff. In contrast, we find that overconfidence does not have a significant effect on the decision to purchase insurance