INSURANCE FOR LOW-PROBABILITY HAZARDS - A BIMODAL RESPONSE TO UNLIKELY EVENTS

Two insurance experiments using real-money consequences and multiple rounds to provide experience are described. In the first experiment, subjects bid for insurance to prevent a fixed loss of $4 at probabilities ranging from .01 to .9. Mean bids were near expected value except at the lowest probability of .01, for which a very bimodal distribution was observed (some subjects bid zero and others bid much more than expected value). A second experiment explored this bimodality at a probability of .01 with loss increased to $40. A similar bimodal distribution was obtained that persisted over 50 rounds of experience. These laboratory results are consistent with field evidence for low-probability hazards, for which people appear either to dismiss the risks or to worry too much about them.