Consumers' collision insurance decisions: a mental models approach to theory evaluation

Using interviews with 74 drivers, we elicit and analyze how people think about collision insurance coverage and decide whether to buy coverage, and if so, what deductible level to carry. We compare respondents' judgments and behaviors to predictions of three models: baseline expected utility (EU) theory, which predicts that insurance is an inferior good, meaning more wealthy people buy less; a modified EU model, which incorporates income constraints and suggests that property insurance is a normal good, meaning more wealthy people buy more; and a mental accounting model which predicts that consumers budget income across consumption categories. The results suggest they purchase insurance as a normal good, guided by a cognitive model that emphasizes budget constraints. Verbal reports reveal a desire to balance two conflicting goals in deductible decisions: keeping premiums 'affordable' and keeping deductible level 'affordable.' Thus, wealth does not distinguish people by risk aversion, but by ability to pay. In other words, the behavior of less wealthy people is not driven by greater risk aversion, but by their lesser ability to pay, both now and later. We find that a simple heuristic using only vehicle value accounts for most decisions of whether to purchase optional collision coverage: out of 45 respondents who did not have loans on their vehicles, 90% of those with vehicles worth more than $1000 carried collision coverage, while less than 30% of those with lower-valued vehicles did.