Willingness to Pay for Low Probability, Low Loss Hazard

Insurance

John C. WhiteheadDepartment of Economics

Appalachian State University

Thanks to Bob Edwards, John Maiolo, Marieke Van Willigan, Ken Wilson and Claudia Williams for their contributions to this research and Jamie Brown Kruse for comments. A previous version of this paper was presented at the Southern Economic Association Annual Meetings in Washington, DC, November 2005 and the American Meteorological Society Annual Meetings in Atlanta, GA, February 2006.

Evacuation Cost Insurance

“Analysis of behavior and policy prescriptions would not be such a problem if low probability natural disasters had small consequences.”

-- Ganderton et al. 2000, page 272.

Literature

• McClelland, Schulze and Coursey (1993)

• Ganderton et al. (2000)

• Ozdemir (2005)

• Burrus, Dumas and Graham (2005)

Data•March 2001 telephone survey •Response rate = 73% (n = 411) •Most respondents had experienced one or more hurricanes (n = 384) •50% evacuated for at least one storm

Empirical Model

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Dependent VariableMany people in coastal areas are safer if they evacuate their home before a hurricane strikes. But evacuating can cost a lot of time, money and lost income. Some people would rather stay at home during a hurricane so that they don’t spend money and lose income. To reduce this problem and increase safety, one plan is to have a hurricane evacuation insurance policy to reimburse people for the costs of evacuation.

Willingness to Pay

• Suppose you could purchase a hurricane evacuation insurance policy from an insurance agent before the next hurricane season. The price of the evacuation insurance is $p each hurricane season. With insurance, you would be reimbursed for all of your evacuation expenses throughout the hurricane season. This would include reimbursement for travel, lodging, food, medical costs and lost income. Do you think you would purchase the hurricane evacuation insurance policy?

% YES

51% = very sure, 44% = somewhat sure, 3% = not sure at all

0

5

10

15

20

25

30

35

40

45

50 100 140 190 240

%YES

Independent Variables

• Policy price = p

• Evacuation probability = r = Σ (ρ × π )

• Evacuation cost = c

• Factors affecting evacuation

Willingness to Pay Models

Had Evacuated for a Recent Hurricane

Had Not Evacuated for a Recent Hurricane

yes yes-sure yes yes-sure

Coeff. t-ratio Coeff. t-ratio Coeff. t-ratio Coeff. t-ratio

Constant 0.84 0.56 2.16 1.23 1.46 0.86 1.66 0.82

ln Price -0.50 -1.69 -0.86 -2.40 -0.99 -2.92 -1.20 -2.84

Probability 1.24 1.22 -0.91 -0.70 5.93 1.71 5.29 1.39

Cost 0.001 3.30 0.001 3.26 0.003 2.81 0.002 1.78

Income -0.002 -0.36 -0.001 -0.17 0.005 0.93 0.011 1.68

χ2 18.47 18.07 22.20 15.94

R2 0.10 0.11 0.11 0.12

Cases 191 191 193 193

WTP 15.94 0.82 14.83 1.18 34.41 2.31 20.14 1.72

Summary

• A majority of respondents would not purchase the product at even the lowest price

• Respondents are rational, ahem, in response to price, risk, cost and expected costs

• Respondents are risk neutral

Problems

• Moral hazard: Δπ/Δx > 0

• Strike Probabilities: ρ > y/t

• Subjective ρ > objective ρ