Financial literacy and precautionary insurance

Arbeitspapier

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.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: ICIR Working Paper Series ; No. 34/19

Classification and Topics

• Classification: Wirtschaft ; Consumer Economics: Theory ; Criteria for Decision-Making under Risk and Uncertainty ; Micro-Based Behavioral Economics: Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making‡ ; Insurance; Insurance Companies; Actuarial Studies
• Subject: financial literacy ; insurance demand ; prudence ; precautionary insurance

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Kubitza, Christian ; Hofmann, Annette ; Steinorth, Petra
• Event: Veröffentlichung
• (who): Goethe University Frankfurt, International Center for Insurance Regulation (ICIR)
• (where): Frankfurt a. M.
• (when): 2019

Further information

• Handle: http://hdl.handle.net/10419/196910
• Last update: 10.03.2025, 11:44 AM CET