Optimism, overconfidence, and insurance decisions

Abstract

We report experimental evidence regarding overconfidence, optimism, and insurance decisions. Our design distinguishes between an individual’s optimism bias and overconfidence bias, a contribu- tion particularly important for understanding insurance decisions related to risks beyond the purchas- er’s control. Results show that optimistic participants incur a higher total cost of risk and are more likely to underinsure than non-optimistic participants, even when purchasing insurance maximizes expected payoffs. In contrast, we find that overconfidence does not significantly affect the decision to insure. However, participants with higher overall overconfidence show larger differences in insur- ance behavior when the risk of loss arises from their own mistakes.