BE CAUTIOUS IN THE LAST MONTH: THE SUNK COST FALLACY HELD BY CAR INSURANCE POLICYHOLDERS

Abstract

AbstractInvestigating a unique large data set, we find that automobile insurance policyholders are more likely to encounter accidents during the last month of the insurance policy term than during any other month. Our interpretation is that this effect is driven by the sunk cost fallacy held by policyholders, which exacerbates their moral hazard. The explanation is that in the last month, policyholders may become concerned that they may “waste” the premiums paid upfront if they have not encountered an accident before the policy expires; thus, they will reduce their accident‐prevention efforts, although the premiums are sunk costs and cannot be reversed.