S-shaped narrow framing, skewness and the demand for insurance

Yichun Chi, Jiakun Zheng and Shengchao Zhuang
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Jiakun Zheng: Renmin University of China = Université Renmin de Chine, China Financial Policy Research Center - Renmin University of China = Université Renmin de Chine
Shengchao Zhuang: University of Nebraska–Lincoln - University of Nebraska System

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Abstract: The existing literature in insurance economics has shown that narrow framing can explain why people buy too little insurance compared to what standard theory predicts. However, there is also ample evidence suggesting people sometimes buy too much insurance. In this paper, we assume S-shaped narrow framing, i.e., the local utility function for evaluating the net insurance payoff is convex in the loss domain but concave in the gain domain, and show that it can reconcile with both insurance puzzles simultaneously. Especially, we show the policyholder under S-shaped narrow framing is more likely to underinsure more negatively skewed risks of loss but to overinsure less negatively skewed risks of loss when only coinsurance is offered. We further characterize the optimal insurance scheme under S-shaped narrow framing while incentive compatibility is satisfied. It contains a straight deductible when the net insurance payoff is negative but partial insurance when the net insurance payoff is positive.

Date: 2022-07
New Economics Papers: this item is included in nep-upt
Note: View the original document on HAL open archive server: https://hal.science/hal-04227435v1
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Published in Insurance: Mathematics and Economics, 2022, 105, pp.279-292. ⟨10.1016/j.insmatheco.2022.04.005⟩

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Journal Article: S-shaped narrow framing, skewness and the demand for insurance (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-04227435

DOI: 10.1016/j.insmatheco.2022.04.005

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