Financial literacy and precautionary insurance

  • This paper studies insurance demand for individuals with limited financial literacy. We propose uncertainty about insurance payouts, resulting from contract complexity, as a novel channel that affects decision-making of financially illiterate individuals. Then, a trade-off between second-order (risk aversion) and third-order (prudence) risk preferences drives insurance demand. Sufficiently prudent individuals raise insurance demand upon an increase in contract complexity, while the effect is reversed for less prudent individuals. We characterize competitive market equilibria that feature complex contracts since firms face costs to reduce complexity. Based on the equilibrium analysis, we propose a monetary measure for the welfare cost of financial illiteracy and show that it is mainly driven by individuals’ risk aversion. Finally, we discuss implications for regulation and consumer protection.

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Author:Christian KubitzaGND, Annette HofmannGND, Petra SteinorthGND
URN:urn:nbn:de:hebis:30:3-772511
Series (Serial Number):ICIR Working Paper Series (No. 34/19)
Publisher:International Center for Insurance Regulation
Place of publication:Frankfurt am Main
Document Type:Working Paper
Language:English
Year of Completion:2019
Year of first Publication:2019
Publishing Institution:Universitätsbibliothek Johann Christian Senckenberg
Release Date:2024/04/11
Tag:financial literacy; insurance demand; precautionary insurance; prudence
Volume:This version: April 2019
Page Number:48
HeBIS-PPN:51762169X
Institutes:Wirtschaftswissenschaften / Wirtschaftswissenschaften
Wissenschaftliche Zentren und koordinierte Programme / Sustainable Architecture for Finance in Europe (SAFE)
Dewey Decimal Classification:3 Sozialwissenschaften / 33 Wirtschaft / 330 Wirtschaft
JEL-Classification:D Microeconomics / D1 Household Behavior and Family Economics / D11 Consumer Economics: Theory
D Microeconomics / D8 Information, Knowledge, and Uncertainty / D81 Criteria for Decision-Making under Risk and Uncertainty
D Microeconomics / D9 Intertemporal Choice and Growth / D91 Intertemporal Consumer Choice; Life Cycle Models and Saving
G Financial Economics / G2 Financial Institutions and Services / G22 Insurance; Insurance Companies
Sammlungen:Universitätspublikationen
Licence (German):License LogoDeutsches Urheberrecht