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Pricing Insurance and Warranties: Ambiguity and Correlated Risks

Author

Listed:
  • Robin M. Hogarth

    (Graduate School of Business, Center for Decision Research, University of Chicago)

  • Howard Kunreuther

    (The Wharton School, Center for Risk and Decision Processes, University of Pennsylvania)

Abstract

This paper reports on the results of a questionnaire study of pricing decisions made by professional actuaries when the probabilities of a loss are either ambiguous or nonambiguous. Theoretical hypotheses derived from the expected utility model were compared with the implications of procedures described by practicing actuaries. Actuaries were asked to act as consultants to a computer manufacturer concerning the price of a warranty. The suggested prices were considerably higher when probabilities were ambiguous than when they were well-specified. These pricing decisions were consistent with the procedures described by actuaries but inconsistent with predictions from expected utility theory when the risks are perfectly correlated. Further insight into the actual decision process is provided by interviews with actuaries and an analysis of comments written on the questionnaire forms. The Geneva Papers on Risk and Insurance Theory (1992) 17, 35–60. doi:10.1007/BF00941956

Suggested Citation

  • Robin M. Hogarth & Howard Kunreuther, 1992. "Pricing Insurance and Warranties: Ambiguity and Correlated Risks," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 17(1), pages 35-60, June.
    • Handle: RePEc:pal:genrir:v:17:y:1992:i:1:p:35-60
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    Citations

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    Cited by:

    1. Feduzi, Alberto & Runde, Jochen, 2011. "The uncertain foundations of the welfare state," Journal of Economic Behavior & Organization, Elsevier, vol. 80(3), pages 613-627.
    2. Borgonovo, Emanuele & Marinacci, Massimo, 2015. "Decision analysis under ambiguity," European Journal of Operational Research, Elsevier, vol. 244(3), pages 823-836.
    3. Kunreuther, Howard & Meszaros, Jacqueline & Hogarth, Robin M. & Spranca, Mark, 1995. "Ambiguity and underwriter decision processes," Journal of Economic Behavior & Organization, Elsevier, vol. 26(3), pages 337-352, May.
    4. Howard Kunreuther & Mark Pauly, 2004. "Neglecting Disaster: Why Don't People Insure Against Large Losses?," Journal of Risk and Uncertainty, Springer, vol. 28(1), pages 5-21, January.
    5. Simon Dietz & Falk Niehörster, 2021. "Pricing ambiguity in catastrophe risk insurance," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 46(2), pages 112-132, September.
    6. Oliver Walker & Simon Dietz, 2012. "Ambiguity and insurance: robust capital requirements and premiums," GRI Working Papers 97, Grantham Research Institute on Climate Change and the Environment.
    7. Skees, Jerry R., 2000. "A role for capital markets in natural disasters: a piece of the food security puzzle," Food Policy, Elsevier, vol. 25(3), pages 365-378, June.
    8. Steul, Martina, 2006. "Does the framing of investment portfolios influence risk-taking behavior? Some experimental results," Journal of Economic Psychology, Elsevier, vol. 27(4), pages 557-570, August.
    9. Mr. S. Nuri Erbas & Chera L. Sayers, 2006. "Institutional Quality, Knightian Uncertainty, and Insurability: A Cross-Country Analysis," IMF Working Papers 2006/179, International Monetary Fund.
    10. Janne Chung & Gary Monroe, 2007. "An Exploratory Study of Counterexplanation as an Ethical Intervention Strategy," Journal of Business Ethics, Springer, vol. 73(3), pages 245-261, July.
    11. Daniela Cagno & Daniela Grieco, 2023. "Insurance Choices and Sources of Ambiguity," Italian Economic Journal: A Continuation of Rivista Italiana degli Economisti and Giornale degli Economisti, Springer;Società Italiana degli Economisti (Italian Economic Association), vol. 9(1), pages 295-319, March.
    12. Dietz, Simon & Walker, Oliver, 2017. "Ambiguity and insurance: capital requirements andpremiums," LSE Research Online Documents on Economics 68469, London School of Economics and Political Science, LSE Library.
    13. Mr. S. Nuri Erbas, 2004. "Ambiguity, Transparency, and Institutional Strength," IMF Working Papers 2004/115, International Monetary Fund.
    14. Jean Desrochers & J. Francois Outreville, 2013. "Uncertainty, Ambiguity and Risk Taking: an experimental investigation of consumer behavior and demand for insurance," ICER Working Papers 10-2013, ICER - International Centre for Economic Research.
    15. Unknown, 1999. "Policy Reform, Market Stability, And Food Security; Proceedings Of A Conference Of The International Agricultural Trade Research Consortium," 1998: Policy Reform, Market Stability, and Food Security Conference, June 1998, Alexandria VA 14538, International Agricultural Trade Research Consortium.
    16. Hossein Morshedlou & Mohammad Reza Meybodi, 2018. "Insurance for Improving User Satisfaction Level," Business & Information Systems Engineering: The International Journal of WIRTSCHAFTSINFORMATIK, Springer;Gesellschaft für Informatik e.V. (GI), vol. 60(6), pages 513-524, December.
    17. Henri LOUBERGE & Harris SCHLESINGER, 1999. "Optimal Catastrophe Insurance with Multiple Catastrophes," FAME Research Paper Series rp7, International Center for Financial Asset Management and Engineering.

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