Becker-DeGroot-Marschak Contract Term Mispricing
RCTClinical Trial
Consumers evaluating complex financial insurance contracts recognize qualitative value changes but struggle to correctly estimate the economic magnitude of specific contract terms relative to actuarial risk [1, 18, 19].
Picture this
It is like bidding on a car warranty where buyers pay slightly more for a policy covering flat tires but fail to realize that another policy covering total engine failure is worth ten times more money [18-20].
What the evidence says
Raising the exit threshold increased willingness to pay by Rs. 11 despite increasing expected payout by Rs. 40–70, whereas reducing millimeter deficit payments reduced willingness to pay by Rs. 12–13 while only lowering expected payout value by Rs. 10–20 [19, 25-27].
- Who was studied
- N = 1,978 farmers in Andhra Pradesh, India bidding on four distinct insurance contract variations [21, 22].
- How
- Incentive-compatible Becker-DeGroot-Marschak (BDM) field experiment eliciting willingness to pay across systematic contract term modifications [18, 23, 24].
What to do
Regulate and standardize retail index insurance contract parameters to prevent commercial insurers from offering policies that exploit consumer misvaluation of severe tail events [17, 18].
From the source
"However, we also show that while farmers can identify changes in the contract that make the policies more or less valuable, they do less well at estimating the economic magnitude of these changes." [18]
How Does Risk Management Influence Production Decisions? Evidence from a Field Experiment