Abstract
Default options may provide a low-cost way of influencing behaviour without modifying incentives and constraining choices between alternatives. However, an improved understanding is needed on whether they are effective when individuals have experience with making the choice in practice and have preferences for specific alternatives. We study whether defaults can be used to increase insurance coverage against low-probability/high-impact risks, like floods, and whether past flood insurance purchases and flooding experience moderate the effect of defaults. Our study uses a naturally occurring difference in experience, comparing the surveyed flood insurance choices of 1,187 homeowners, half of whom are in the Netherlands, where flood insurance penetration rates are low and recent flooding caused minor losses, and the other half of whom are in the United Kingdom (UK), where the opposite is true. We find defaults are effective among homeowners with little to no flood-related experience: in the Netherlands defaults increase the likelihood of insuring by between 17 and 18 percentage points. Although there is no overall effect of defaults in the UK, defaults increase flood insurance coverage for risk averse individuals, and those who have no reported previous flood experience and have not purchased flood insurance. Anticipated regret about not having insurance coverage in the event of a flood, and perceptions about the insurance cost explain between 34 and 37 percent of the relationship between the default and flood insurance demand. We discuss policy implications of our findings.
Highlights
Whereas rational economic approaches assume individuals are fully informed and maximize their expected utility, behavioural economics recognizes individuals’ cognitive limitations that may lead them to fail to act in their own self-interest (Bhargava and Loewenstein, 2015)
We consider flooding experience, reported insurance purchasing experience and risk preference as moderators because we expect these variables may influence the strength of the relation between default assignment and flood insurance demand
The results are consistent with our expectations that defaults are more influential in the Netherlands, where flood insurance penetration rates and flooding experiences are lower in practice than the United Kingdom (UK)
Summary
Whereas rational economic approaches assume individuals are fully informed and maximize their expected utility, behavioural economics recognizes individuals’ cognitive limitations that may lead them to fail to act in their own self-interest (Bhargava and Loewenstein, 2015). Individuals are more likely to act in accordance with rational economic theory if they have experience related to the decision, because there are opportunities for learning (List, 2003). Defaults are a type of choice architecture which has received limited attention with respect to insurance against low-probability/high-impact (LPHI) risk, like floods, which is the focus of this study (Kunreuther, 2015; Kunreuther and Pauly, 2018).. Floods are the most frequent and costly natural hazards worldwide and homeowners often underinvest in measures that mitigate these risks (Kunreuther and Pauly, 2004; Browne et al, 2015; Wallemacq, 2018; Kousky, 2018), so there is a rationale for using defaults to encourage individuals to protect themselves against future losses by purchasing insurance. Defaults are a type of choice architecture which has received limited attention with respect to insurance against low-probability/high-impact (LPHI) risk, like floods, which is the focus of this study (Kunreuther, 2015; Kunreuther and Pauly, 2018). Floods are the most frequent and costly natural hazards worldwide and homeowners often underinvest in measures that mitigate these risks (Kunreuther and Pauly, 2004; Browne et al, 2015; Wallemacq, 2018; Kousky, 2018), so there is a rationale for using defaults to encourage individuals to protect themselves against future losses by purchasing insurance. Meyer and Kunreuther (2017) suggest developing strategies for improving preparedness for disasters by recognizing decision biases that lead to underinvestment in protective behaviours
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