Showing papers in "Journal of Risk and Uncertainty in 1996"
TL;DR: The authors examines why homeowners have not voluntarily adopted cost-effective protective measures and have limited interest in purchasing insurance and proposes a disaster management program which utilizes insurance coupled with well-enforced building codes to reduce future damage.
Abstract: Losses from natural disasters have increased in recent years due to growth of population in hazard-prone areas and inadequate enforcement of building codes. This article first examines why homeowners have not voluntarily adopted cost-effective protective measures and have limited interest in purchasing insurance. It then proposes a disaster-management program which utilizes insurance coupled with well-enforced building codes to reduce future damage. Banks and financial institutions play a key role in this program by requiring inspections of homes as a condition for a mortgage. New forms of reinsurance coverage against catastrophic losses from natural disasters are necessary to protect insurers against potential insolvency from the next mega-disaster.
498 citations
TL;DR: In this paper, the authors attributed the subadditivity of judged probabilities to the fact that an event had greater impact on prices when it turned an impossibility into a possibility or a possibility into a certainty than when it merely made a possibility more or less likely.
Abstract: Professional options traders priced risky prospects as well as uncertain prospects whose outcomes depended on future values of various stocks. The prices of the risky prospects coincided with their expected value, but the prices of the uncertain prospects violated expected utility theory. An event had greater impact on prices when it turned an impossibility into a possibility or a possibility into a certainty than when it merely made a possibility more or less likely, as predicted by prospect theory. This phenomenon is attributed to the subadditivity of judged probabilities.
232 citations
TL;DR: In this paper, the authors analyzed the frequency of automobile bodily injury liability (BIL) claims and found that attitudes toward dishonest behavior are related to BIL claims frequency, and thus provided evidence of significant moral hazard in automobile insurance markets.
Abstract: This article provides new evidence on moral hazard in insurance markets by analyzing the frequency of automobile bodily injury liability (BIL) claims. We conduct cross-sectional regressions of statewide BIL claims frequency rates on variables representing state economic, demographic, and legal characteristics that affect the marginal costs and benefits of filing claims. As an indicator of moral hazard, we use survey data on consumer attitudes toward various types of dishonest behavior relating to insurance claims. The results provide strong support for the hypothesis that attitudes toward dishonest behavior are related to BIL claims frequency, and thus provide evidence of significant moral hazard in automobile insurance markets.
156 citations
TL;DR: This article argued that for systemic reasons, the government is much less effective than the private property/casualty insurance market in providing coverage of losses generally, but especially of losses in contexts of catastrophes.
Abstract: This article addresses the comparative advantage of the government to the private property/casualty insurance industry for the provision of insurance coverage for catastrophic losses. That the government can play an important role as an insurer of societal losses has been a central public policy principle since at least the New Deal. In addition, our government typically automatically provides forms of specific relief following unusually severe or unexpected disasters, which itself can be viewed as a form of ex post insurance. This article argues that, for systemic reasons, the government is much less effective than the private property/casualty insurance market in providing coverage of losses generally, but especially of losses in contexts of catastrophes.
123 citations
TL;DR: This paper found that the average willingness to pay for a program which would increase the expected length of life by one year, conditional on having survived to the age of 75 years, is lower than $1,500.
Abstract: This study reports an attempt to measure the value of an increased survival probability at advanced ages. It turns out that the average willingness to pay for a program which would increase the expected length of life by one year, conditional on having survived to the age of 75 years, is lower than $1,500. The willingness to pay increases with a person's age, but at a low and seemingly constant rate (1–4 percent per year).
112 citations
TL;DR: In this paper, an ideal competitive market fcr risk-shifting is described; the payments received by individuals depend on the resolution of all the uncertainties at the time of the market, including, for example, damages to all parties, not just to the insured.
Abstract: Under certain conditions, risk-sharing and, in particular, insurance are mutually advantageous transactions. An ideal competitive market fcr risk-shifting is described; the payments received by individuals depend on the resolution of all the uncertainties at the time of the market, including, for example, damages to all parties, not just to the insured. In an ideal system, premiums depend only on the total damage in a given state, not on its distribution over individuals. In particular, mitigation measures are optimally induced. The differences between the ideal model of insurance and the real world are described, and some explanations offered.
111 citations
TL;DR: In this paper, the authors show that some types of altruists may be willing to pay more for a private risk reduction than for a uniform risk reduction of the same magnitude, but need not.
Abstract: In this study, one group of respondents is offered to purchase a safety device to be installed in their cars, while another group is offered a public safety program (improved road quality) which results in the same size risk reduction. In terms of the value of a statistical life, our results are very reasonable. However, the WTP for the private safety device ishigher than the WTP for the public safety measure. Drawing on a model developed by Jones-Lee (1991), we show that some types of altruists may, but need not, be willing to pay more for a private risk reduction than for a uniform risk reduction of the same magnitude. Still, our empirical results are surprising, and further empirical research seems warranted.
106 citations
TL;DR: In this paper, the authors consider the consumption of catastrophes, stressing the way that we disseminate information about them, and respond, possibly on a non-rational basis, possibly due to inappropriate incentives, human actions often exacerbate outcomes.
Abstract: Catastrophes can profitably be thought of as economic events. This essay begins by considering the consumption of catastrophes, stressing the way that we disseminate information about them, and respond, possibly on a nonrational basis. Catastrophes are produced through a combination of actions by nature and humans. Due to inappropriate incentives, human actions often exacerbate outcomes. This is particularly true in “micromotive” situations, such as the AIDS epidemic, where actions by many players produce a collectively bad outcome. Mechanisms to prevent or ameliorate catastrophes—liability, insurance, and government regulation—are considered.
99 citations
TL;DR: Using a new data source and estimation framework, evidence is found that moral hazard response explains most of the 30% increase in the proportion of soft tissue injuries during the 1980s.
Abstract: During the last decade, the distribution of workers' compensation claims has exhibited a marked shift towards soft tissue injuries such as sprains, strains, and low back claims. There are three possible explanations for this trend; (1) safety incentives induced by workers compensation or OSHA may have reduced other, traumatic claims; (2) the movement away from heavy manufacturing and the 1980 construction recession may have changed the underlying risk of a workplace injury; and (3) there has been moral hazard behavior on the part of workers and health care providers. Using a new data source and estimation framework, we find evidence that moral hazard response explains most of the 30% increase in the proportion of soft tissue injuries during the 1980s.
88 citations
TL;DR: In this paper, the authors show that optimal LTC insurance must be small in the presence of bequests, and that the failure of private long-term care insurance to diffuse into middleclass households may be explained by the fact that the bequest instrument is fully available to the current generation of parents, who for the first time since 1914 are in a position to bequeath an intact stock of capital in major industrialized countries.
Abstract: The growing demand for long-term care (LTC) causes the relationship between children and their parents to gain increased importance for society. Parents may create incentives for children to provide LTC through bequests, or they may purchase LTC insurance. While these instruments have been analyzed separately in the literature, this article shows that optimal LTC insurance must be small in the presence of bequests. Thus, the failure of private LTC insurance to diffuse into middle-class households may be explained by the fact that the bequest instrument is fully available to the current generation of parents, who for the first time since 1914 are in a position to bequeath an intact stock of capital in major industrialized countries.
66 citations
TL;DR: In this article, the authors build two experimental markets to examine individual valuations of risk reductions with two risk management tools: self-insurance and self-protection, and they find no positive evidence that the risk-reducing mechanisms constitute a "frame".
Abstract: We build two experimental markets to examine individual valuations of risk reductions with two risk-management tools: self-insurance and self-protection. We find no positive evidence that the risk-reducing mechanisms constitute a “frame.” Ambiguity in the probability on average affects valuation only weakly, and changes in the representation of ambiguity do not alter valuation. Finally, unlike the results obtained by Hogarth and Kunreuther for the case of market insurance, our findings do not provide a strong support for the “Anchoring and Adjustment” ambiguity model.
TL;DR: In this article, a methodology for rational pricing of catastrophe insurance is described, which has two components: a solvency-and stability-based pricing framework, and an engine to quantify the loss variability that drives solvencies and stability.
Abstract: A methodology for rational pricing of catastrophe insurance is described. The methodology has two components: a solvency- and stability-based pricing framework, and an engine to quantify the loss variability that drives solvency and stability. Generalization to account for contagious effects of catastrophes and multiple occurrence of peril is presented in detail.
TL;DR: In this paper, the authors argue that these intrinsic contracting problems do not justify invalidating ordinary insurance contracts or forcing insurers to cover catastrophic losses, and that ordinary contract solutions are always imperfect, but superior to the regulatory maze.
Abstract: Socializing risks from catastrophic losses is difficult even in an ideal political environment, owing to different estimates of low probability risks, solvency constraints, dangers of moral hazard, and high loss correlation. However, these intrinsic contracting problems do not justify invalidating ordinary insurance contracts or forcing insurers to cover catastrophic losses. Yet, political pressures forcing insurance subsidies now induce inefficient decisions in siting and construction, with high expected social losses. Ordinary contract solutions are always imperfect, but superior to the regulatory maze. Unfortunately, patterns of legislation and court decisions are running in the wrong direction.
TL;DR: In this paper, the authors identify the common characterizing property, the comonotonic sure-thing principle, that underlies the rank-dependent direction in non-expected utility.
Abstract: This article identifies the common characterizing property, the comonotonic sure-thing principle, that underlies the rank-dependent direction in non-expected utility. This property restricts Savage's sure-thing principle to comonotonic acts, and is characterized in full generality by means of a new functional form—cumulative utility—that generalizes the Choquet integral. Thus, a common generalization of all existing rank-dependent forms is obtained, including rank-dependent expected utility, Choquet expected utility, and cumulative prospect theory.
TL;DR: In this paper, the authors apply certain principles of inference to a practical, financial question, and argue that decision making should be Bayesian, that classical (R. A. Fisher, Neyman-Pearson) inference can be highly misleading for Bayesians as can the use of diffuse priors, and that Bayesian statisticians should show remote clients with a variety of priors how a sample implies shifts in their beliefs.
Abstract: This is the first of two articles which apply certain principles of inference to a practical, financial question. The present article argues and cites arguments which contend that decision making should be Bayesian, that classical (R. A. Fisher, Neyman-Pearson) inference can be highly misleading for Bayesians as can the use of diffuse priors, and that Bayesian statisticians should show remote clients with a variety of priors how a sample implies shifts in their beliefs. We also consider practical implications of the fact that human decision makers and their statisticians cannot fully emulate Savage's rational decision maker.
TL;DR: In this article, the authors show how Bayesians should shift beliefs among a family of models concerning the probability distribution of daily changes in the Standard & Poor 500 Index, given a particular sample.
Abstract: The present article shows how Bayesians should shift beliefs among a family of models concerning the probability distribution of daily changes in the Standard & Poor 500 Index, given a particular sample. The preceding article in this issue showed that classical (R.A. Fisher, Neyman-Pearson) inference can be highly misleading for Bayesians, as can the assumption of a diffuse prior. The present article discusses how to bound Bayesian shifts in belief for compound hypotheses generally, as well as the specific shifts in beliefs among simple and compound hypotheses implied by the particular sample.
TL;DR: In this paper, the authors argue that the choice-theoretic definitions of subjective probabilities involve a tacit convention that is not implied by the axioms, and, as a consequence, they do not necessarily represent the decision makers' beliefs.
Abstract: Choice-theoretic definitions of subjective probabilities originated with the work of Ramsey and de Finetti and attained their definitive form in the work of Savage. These probabilities are intended to provide a numerical representation of a decision maker's beliefs regarding the likely realization of alternative events. In this article, I argue that the choice-theoretic definitions of subjective probabilities involve a tacit convention—namely, state-independent utility functions—that is not implied by the axioms, and, as a consequence, choice-theoretic subjective probabilities, even when they exist, do not necessarily represent the decision makers' beliefs.
TL;DR: The global use of derivative instruments has grown in importance, because they are less expensive tools for hedging risks and for investing in securities as discussed by the authors, and because the size of the derivative market appears so large, legislators and regulators around the world, who have limited information about derivatives, fear that further possible bankruptcies pose a systemic risk to the economy.
Abstract: The global use of derivative instruments has grown in importance, because they are less expensive tools for hedging risks and for investing in securities. Because several entities have incurred substantial losses in derivatives, leading to bankruptcy in a few cases, and because the size of the derivative market appears so large, legislators and regulators around the world, who have limited information about derivatives, fear that further possible bankruptcies pose a systemic risk to the economy. This fear is unwarranted. Affected entities will continue to make infrastructure investments to support their valuable derivative business, a more beneficial alternative to political solutions.
TL;DR: In this article, the authors used a Cox proportional hazards model to analyze changes in the risk of unplanned outages in U.S. nuclear power plants after the Three Mile Island (TMI) accident.
Abstract: This study uses a Cox proportional hazards model to analyze changes in the risk of unplanned outages in U.S. nuclear power plants after the Three Mile Island (TMI) accident. The unplanned outage hazard is related to safety by the fact that most such outages begin with unplanned reactor scrams. These place extreme stresses on plant equipment, increasing the risk of serious accident. The estimates indicate that the Nuclear Regulatory Commission (NRC)-led efforts to improve nuclear plant safety after TMI were followed by substantial reductions in the risk of unplanned outages.
TL;DR: Panel data is used to suggest that the relationship between income and the probability of death is greater for poor people than for the rich, and that income transfers between income groups which are ignored in traditional cost-benefit analysis will affect the conclusions of health-health analysis significantly.
Abstract: Articles developing health-health analysis have used the observation that richer people tend to face reduced mortality risk to estimate the break-even cost per life saved of health regulations. If government requires that the private sector spend more than this break-even cutoff, the risk of dying due to reduced health investment is increased by more than it will be reduced by the direct action of the health regulation. We use panel data to suggest that the relationship between income and the probability of death is greater for poor people than for the rich. As a consequence, break-even cutoffs are roughly twice as large for the richest 20% of the population than they are for the poorest 20%. The nonlinearity in the income-to-mortality linkage also implies that income transfers between income groups which are ignored in traditional cost-benefit analysis will affect the conclusions of health-health analysis significantly.
TL;DR: In this article, the authors explore the implications for public policy of the assumption that policy makers exhibit the same cognitive and perceptual problems as other citizens regarding catastrophic events, and conclude that the same factors that cause citizens to behave inefficiently in preparing for and responding to disasters also will cause inefficiencies in policies concerning catastrophic events.
Abstract: The purpose of this essay is to explore the implications for public policy of the assumption that policy makers exhibit the same cognitive and perceptual problems as other citizens regarding catastrophic events. The key conclusion is that the same factors that cause citizens to behave inefficiently in preparing for and responding to disasters also will cause inefficiencies in policies concerning catastrophic events. Among the more important expected pathologies of disaster policies are: (1) a failure to balance benefits and costs at the margin for different types of disasters, due to cognitive pathologies such as availability and overconfidence; (2) a tendency for policy to underinvest in protection and overinvest in response; and (3) a skepticism for policies based on sound insurance principles for spreading costs and assessing claims.
TL;DR: In this article, participants were asked to consider themselves either as potential victims of a road accident or as relatives of potential victims and to state their willingness to pay to reduce the likelihood of such an accident occurring.
Abstract: The accurate description of the contingent market is a necessary condition for eliciting willingness-to-pay values. So far, however, the contingent market for a reduction in the risk of being the victim of a road accident has only been broadly specified. This Swiss experiment attempts to define the good to be purchased by respondents with greater precision. It concentrates on the human costs of road accidents, i.e., pain, suffering, and bereavement. Respondents were asked to consider themselves either as potential victims of a road accident or as relatives of potential victims and to state their willingness to pay to reduce the likelihood of such an accident occurring.
TL;DR: In this article, the authors investigate the descriptive performance of rank-dependent utility (RDU) in the context of choice under ambiguity and use the axiomatic difference between RDU and EU to critically test RDU against EU.
Abstract: Experimental investigations of non-expected utility have primarily concentrated on decision under risk (“probability triangles”). The literature suggests, however, that ambiguity is one of the main causes for deviations from expected utility (EU). This article investigates the descriptive performance of rank-dependent utility (RDU) in the context of choice under ambiguity. We use the axiomatic difference between RDU and EU to critically test RDU against EU. Surprisingly, the RDU model does not provide any descriptive improvement over EU. Our data suggest other “framing” factors that do provide descriptive improvements over EU.
TL;DR: In this article, the authors show how the order of linear stochastic dominance proposed by Gollier (1995) can be applied to situations with dependent risky assets and obtain the necessary and sufficient condition for a change in the joint distribution of returns to yield an unambiguous comparative statics result when the two assets are risky.
Abstract: In this article, we show how the order of Linear Stochastic Dominance proposed by Gollier (1995) can be applied to situations with dependent risky assets. This order was shown to be the least constrained necessary and sufficient condition to guarantee that all risk-averse agents reduce their risky position when an increase in risk is imposed. This was done in a model with only one source of risk, as in the standard portfolio problem with one safe asset and one risky asset. We obtain the necessary and sufficient condition for a change in the joint distribution of returns to yield an unambiguous comparative statics result when the two assets are risky. We show in particular that the concept of Linear Stochastic Dominance is sufficient to generate the desired result. These results are linked to existing sufficient conditions in the one-safe-one-risky-asset model, as the condition of strong increase in risk or the monotone likelihood ratio order. They are also compared to those in models where restrictions are on the set of concave utility functions.
TL;DR: In this article, the actual events of the Bhopal gas disaster are examined as a prelude to considering the social treatment of catastrophic risks of this variety, including asbestos liability.
Abstract: This article examines the actual events of the Bhopal gas disaster as a prelude to considering the social treatment of catastrophic risks of this variety. In the context of the conference, Bhopal is held out to be symbolic of man-made catastrophes having sudden impact and is therefore the contrasting episode to an examination of the symbolic episode for gradual man-made catastrophes, asbestos liability. Bhopal is then connected to the circumstances which created a shortage of commercial catastrophe liability insurance in the 1980s. Its influence on the restructuring of the market is then discussed. A commentary on the buying habits of large industrial corporations is also included.
TL;DR: Asbestos litigation triggered much of the public action against asbestos, as asbestos cases constituted the majority of all product liability cases in the federal courts from 1988 to 1991 as mentioned in this paper. But the litigation costs have, however, been substantial, almost three times as great as the amounts transferred to asbestos disease victims.
Abstract: The level of asbestos risk varies widely, with insulation workers facing risks many orders of magnitude greater than other groups, such as school children. After a period of regulatory neglect, asbestos risks are now among the mos stringently regulated risks, with costs per case of cancer prevented on the order of $100 million. Asbestos litigation triggered much of the public action against asbestos, as asbestos cases constituted the majority of all product liability cases in the federal courts from 1988 to 1991. The litigation costs have, however, been substantial, almost three times as great as the amounts transferred to asbestos disease victims. Risk communication potentially could promote efficient risk levels and victim compensation.
TL;DR: In this paper, global risk management strategies based on probabilistic risk analysis and its extension to include management factors are described, drawn mostly from the recent research of the Industrial Engineering Risk Research Group at Stanford (the tiles of the U.S. Space Shuttle, offshore platforms, marine pipelines, and anesthesia in modern hospitals).
Abstract: Industries that deal with hazardous systems are faced with the task of managing a spectrum of risks within resource contraints. They have essentially two options that can be combined in a global risk-management strategy: insurance (loss sharing) and risk mitigation through technical and organizational measures. In this article, global risk-management strategies based on probabilistic risk analysis and its extension to include management factors are described. Some issues and solutions are illustrated through practical examples, drawn mostly from the recent research of the Industrial Engineering Risk Research Group at Stanford (the tiles of the U.S. Space Shuttle, offshore platforms, marine pipelines, and anesthesia in modern hospitals).
TL;DR: In this paper, the authors explain how lobbying pressure intensifies tax-transfer inefficiencies in disaster prevention and relief, and show that the social welfare tradeoff in the government's joint provision of safety regulation and disaster relief is distorted by disinformational lobbying activity by disaster-exposed households and by conflict between principles of horizontal and vertical equity.
Abstract: This article explains how lobbying pressure intensifies tax-transfer inefficiencies in disaster prevention and relief. The social-welfare tradeoff in the government's joint provision of safety regulation and disaster relief is distorted by disinformational lobbying activity by disaster-exposed households and by conflict between principles of horizontal and vertical equity. Horizontal equity presupposes that no group of taxpayers wants to transfer wealth ex ante to equally wealthy disaster-exposed parties. But vertical equity implies that, when disaster strikes, households that were previously able to hide the mitigability of their exposure to a ratable hazard can nevertheless extract sizable transfers from other taxpayers ex post.
TL;DR: In this paper, an approach for assessing preferences in the form of a finite-dimensional, linear-lexicographic utility function is presented. But it does not take the decision consequences as general descriptions, but it can exploit an available and conformable multiattribute structuring.
Abstract: We outline an approach for assessing preferences in the form of a finite-dimensional, linear-lexicographic utility function when they lack the continuity properties necessary for representing them in the form of a real-valued, von Neumann-Morgenstern utility function. This approach takes the decision consequences as general descriptions, but it can exploit an available and conformable multiattribute structuring.
TL;DR: In this article, the structure and assessment of state matrix probabilities in a lexicographic generalization of the traditional subjective expected utility model for decision under uncertainty are discussed. But the authors do not consider the model in this paper.
Abstract: This article clarifies the structure and assessment of state matrix probabilities in a lexicographic generalization of the traditional subjective expected utility model for decision under uncertainty. It is a companion and natural successor to “Structuring and Assessing Linear Lexicographic Utility” by the same authors.