Affordability of National Flood Insurance Program Premiums Report 1 (2015) / Chapter Skim
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4The Insurance Purchase Decision
4The Insurance Purchase Decision
Pages 51-64
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From page 51... ...
These two choice models provide the necessary context for reviewing empirical data on factors that affect insurance purchase decisions. Insights that can be useful for FEMA's efforts to make flood insurance purchase more attractive to households are presented on the basis of this literature review.1 RATIONAL ACTOR MODEL OF CHOICE The rational actor choice model (well known in the economics literature)
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From page 52... ...
The rational actor model is most often used to formulate and test hypotheses about the role of prices in decision making. In the flood insurance purchase decision, the price would be the premium paid.
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From page 53... ...
Neither approach produced a statistically significant relationship between the average premium and the probability of purchasing insurance. A RAND Corporation study used a national sample of 5,472 singlefamily homes in a logistic model to estimate flood insurance purchase (Dixon, et al., 2006)
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From page 54... ...
It also was noted that flood insurance purchases increase with educational attainment, with increased proportion of black households, and with age. Only a few conclusions can be drawn from the literature: • Overall, the probability of insurance purchase is quite inelastic with respect to either the average cost of coverage (Dixon, et al., 2006)
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From page 55... ...
The authors attributed that unexpected result to collinearity: both disaster aid and insurance purchases are thought to positively correlate to the level of risk. Another 2000 study found no evidence of demand suppression by disaster aid (Landry and Kriesel, 2000)
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From page 56... ...
At best, the effect of perceptions of aid on the flood insurance purchase decision remains an open question. BEHAVIORAL MODEL OF CHOICE Behavioral models of choice argue that nonfinancial considerations and intuitive thinking can be used to understand choices.
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From page 57... ...
Three select findings from the literature on insurance purchase decisions are presented in this section: prospect theory, status quo bias (a reluctance to consider alternatives to the current condition) , and availability heuristic (considering the most recent event that occurred most recently to be the most likely)
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From page 58... ...
. Status Quo Bias A flood insurance purchase decision is made when a homeowner buys a house in the floodplain and is considering whether to purchase flood insurance for the first time or when a policy expires and a homeowner has to decide whether to renew it.
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From page 59... ...
Data from the annual American Community Survey over the period covered by the flood insurance dataset revealed that the median length of residence was 5-6 years -- somewhat higher than the median tenure of flood insurance of 2-4 years. That finding of higher insurance purchase after catastrophe is often true even when premiums increase (unlike NFIP policies)
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From page 60... ...
More generally, calling attention to the benefits of insurance by focusing on a specific event such as Hurricane Sandy, is likely to be more effective in increasing takeup rates than framing a general message in terms of reducing damage from future floods or hurricanes. Even before 9/11, controlled experiments revealed that consumers are willing to pay more for insurance against a plane crash caused by terrorists than for flight insurance against any event, a counterintuitive finding in that by definition "any event" includes a terrorist attack (Johnson et al., 1993; Kunreuther et al., 2013)
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From page 61... ...
Some households will use some of the time for a deliberative process when making an insurance purchase decision. Others may use mental shortcuts.
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From page 62... ...
An illustration suggests how choice architecture might result in people's buying and maintaining flood insurance policies. An analysis of the entire portfolio of the NFIP revealed that more than half of all NFIP policies (mandatory and voluntary)
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From page 63... ...
Empirical studies have found that premium prices may affect takeup rates although the size of that effect is small. The effect of the avail ability of disaster aid on insurance purchase decisions is uncertain.
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