Demand for multi-year insurance: Experimental evidence

Howard Kunreuther, Erwann Michel-Kerjan

Property insurance is currently sold as a one-year contract. This poses problems in the market by creating unnecessary volatility in the aftermath of a disaster as many insurers may decide not to renew policies or ask for a much higher premium. On the demand side, empirical data with respect to flood insurance reveals that many individuals let their annual insurance policy lapse after a few years. Multi-year insurance (MYI) with stable premiums over time can address both these problems; however, it is unclear whether there will be significant demand for such coverage. We examined the demand and supply of annual and multi-year insurance contracts with respect to protection against a catastrophic risk, such as a hurricane or earthquake, in a competitive market. We utilized a web-based experiment to determine the demand for multi-year insurance using a representative sample of 455 adults in the United States with significant real money at stake. In a repeated 2-period game, subjects have an opportunity to purchase one-period contracts, two-period contracts or no insurance against the risk of a hurricane causing damage to their property.


Major Findings

  • We find that when insurance is actuarially priced, more than 5 times as many people favor two-period over one-period policies. The demand for two-period policies remains high even when the premium is 5 percent and 10 percent above the actuarially fair price and the annual policy is still priced at actuarially fair rates. Furthermore, when a two-period contract is offered to individuals in addition to a one-period policy, total demand for insurance increases.
  • As income increases, the average subject is more likely to be uninsured. Highly risk-averse individuals are more likely to purchase 2-period rather than 1-period policies. Demand for 2- -period policies slightly increases when a hurricane occurred earlier in the experiment, maybe because individuals were able to appreciate the value of a stable premium rather than having it increase significantly after a disaster had they purchased 1-period policies.


Broader Impacts

  • Our studies will help policy makers learn how to incentivize homeowners to invest in loss reduction measures and insurance prior to a disaster and develop strategies for effective economic recovery after a catastrophe.
  • This research is helping to inform policymakers in the areas of catastrophic risk management and has directly influenced legislation including the Biggert-Waters Flood Reform Act of 2012, which adopts our guiding principles for insurance:
    • 1. Premiums would reflect risk for second homes and those that have had repetitive flooding based on updated flood maps to provide signals to individuals as to the hazards they face and to encourage them to engage in cost‐effective mitigation measures to reduce their vulnerability to catastrophes.
    • 2. To address equity and affordability issues, homeowners currently residing in flood‐prone areas whose premiums increased and required special treatment (e.g., low income residents) would be given a means tested insurance voucher to reflect the difference. The new legislation authorizes a study by the National Academy of Sciences that would examine the feasibility of these vouchers.
  • The PI (Howard Kunreuther) has had briefings with Congressional staff and has given Congressional testimony.


CRED2 Award (2010-2015): Funding was provided under the cooperative agreement NSF SES-0951516 awarded to the Center for Research on Environmental Decisions.

For more information, visit The Wharton Risk Management and Decision Processes Center.