No abstract

Despite the large literature on anomalies in risky choice, very little research has explored the relevance of these insights in real insurance markets. This paper uses new data on consumers' choices of deductibles for home insurance to provide evidence that a surprising level of risk aversion over modest stakes is a reality in the market. Most customers purchase low deductibles despite costs significantly above the expected value. Fitting these choices to a standard model of risk aversion yields implausibly large measures of risk parameters. Potential explanations and the implications of these results for understanding the market for insurance are discussed. (JEL D14, D81, G21, G22)

along with those of various seminar and conference participants. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peerreviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.

We examine the health plan choices that 23,894 employees at a U.S. firm made from a large menu of options that differed only in financial cost-sharing and premium. These decisions provide a clear test of the predictions of the standard economic model of insurance choice in the absence of choice frictions because plans were priced so that nearly every plan with a lower deductible was financially dominated by an otherwise identical plan with a high deductible. We document that the majority of employees chose dominated plans, which resulted in excess spending equivalent to 24% of chosen plan premiums. Low-income employees were significantly more likely to choose dominated plans, and most employees did not switch into more financially efficient plans in the subsequent year. We show that the choice of dominated plans cannot be rationalized by standard risk preference or any expectations about health risk. Testing alternative explanations with a series of hypothetical-choice experiments, we find that the popularity of dominated plans was not primarily driven by the size and complexity of the plan menu, nor informed preferences for avoiding high deductibles, but by employees’ lack of understanding of health insurance. Our findings challenge the standard practice of inferring risk preferences from insurance choices and raise doubts about the welfare benefits of health reforms that expand consumer choice.

M any people state a desire to change health-related behaviors, yet struggle to do so. These behavioral problems in domains such as weight loss, smoking, and exercising have helped to motivate a rich literature in economics on time-inconsistent behavior (Strotz 1955(Strotz -1956Laibson 1997; Rabin 1999, 2001;Loewenstein, O'Donoghue, and Rabin 2003;DellaVigna and Malmendier 2006). This literature has shown that time inconsistency can generate patterns of behavior that lead to both "internalities," where one's short-run actions are perceived as suboptimal from one's long-run perspective, and traditional externalities coming through higher group-rated health insurance costs and spending on Medicare and Medicaid (Finkelstein et al. 2009).In the face of these problems, there is increasing interest from firms, insurance companies, policy makers, and health professionals in using financial incentives to motivate changes in health behaviors (Volpp et al. 2009a;Baicker, Cutler, and Song