Question #30976

explain how the demand for insurance would change if the probability of accident increases

Expert's answer

Insurance demand changes according to the different probabilities of accidents.. When faced with low probability losses, (1) some decision makers buy inadequate insurance, while (2) others are eager to buy insurance even when such insurance is not good value. Furthermore, (3) keeping the expected loss fixed, there is a probability below which the take-up of insurance drops dramatically, and (4) the proportion of decision makers that are split between (1) and (2) depends on the context and the frame of the problem. Expected utility (EU) fails on 1-4. Itís main alternatives, rank dependent utility (RDU) and cumulative prospect theory (CP) satisfy 2 but fail on 1, 3, 4.

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