Risk reduction in compulsory disaster insurance: Experimental evidence on moral hazard and financial incentives

• Published in: Journal of behavioral and experimental economics Vol. 84; p. 101500
• Main Authors: Mol, Jantsje M., Botzen, W. J. Wouter, Blasch, Julia E.
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier Inc 01.02.2020; Elsevier Science Ltd
• Subjects: Behavioral insurance; Damage-reduction measures; Disaster insurance; Incentives; Insurance policies; Investments; Lab experiment; Loans; Markets; Monetary incentives; Moral hazard; Natural disasters; Probability; Risk; Risk assessment; Risk aversion; Risk factors; Strategies; Damage-reduction measures; Behavioral insurance; Natural disasters; Lab experiment; Moral hazard
• ISSN: 2214-8043; 2214-8051
• DOI: 10.1016/j.socec.2019.101500

•New investment game to investigate financial incentives for flood damage reduction in the lab.•Moral hazard is less of a problem in a natural disaster insurance market where probabilities are low.•Insurance premium discount can increase investments in damage reduction.•Risk aversion, perceived efficacy of protective measures and worry of flooding can increase investments in damage reduction. In a world in which economic losses due to natural disasters are set to increase, it is essential to study risk reduction strategies, including individual homeowner investments in damage-reducing (mitigation) measures. In this lab experiment (N = 357), we investigated the effects of different financial incentives, probability levels, and deductibles on self-insurance investments in a natural disaster insurance market with compulsory coverage. In particular, we examined how these investments are jointly influenced by financial incentives, such as insurance, premium discounts, and mitigation loans. We also studied the influence of behavioral characteristics, including individual time and risk preferences. We found that investments increase when the expected value of the damage increases (i.e., higher deductibles, higher probabilities). Moral hazard is found in the high-probability (15%) scenarios, but not in the low-probability (3%) scenarios. This suggests that moral hazard is less of an issue in an insurance market where probabilities are low. Our results demonstrate that a premium discount can increase investment in damage-reduction, as can a policyholder‘s risk aversion, perceived efficacy of protective measures, and worry about flooding.