It’s not so surprising when surveys show that the public doesn’t understand what their auto or home insurance policies cover — frankly, many people only have them at all because the law or a mortgage or car lender requires it. If the law didn’t require minimum limits on auto insurance, what percentage of people do you think would buy it anyway? I don’t know if anyone has ever tested for that answer, but my guess is a third to a half of the public would not buy any liability insurance at all.
Here’s a survey done on behalf of MetLife that contains a perplexing fact. About 45 percent of people who rent cars purchase one form or another of insurance over the counter, even though most of them are covered by their own primary auto policies. What is the thinking behind these purchases? Let me ask the question this way. If someone knew their auto policy had lapsed, but needed to drive to work that day and wouldn’t be able to renew the policy until tomorrow, what percentage of folks would go ahead and drive the car uninsured for just one day? A lot. After all, we drive every day and the chances of being in an accident on any given day are small. So why, even leaving out the fact that most people are covered for collision and liability by their own primary insurance, does the analysis change when it comes to renting a car? You tell me, I don’t know the answer.
This post on Slate concerns a similar phenomenon — people overinsuring against small risks. This is something that has been measured in a variety of contexts: for example, if you ask people how much they would pay in the increased price of a product to reduce the chance of being severely harmed by that product from one in a million to one in 10 million, it is surprising that most people would pay a substantial premium for this, even though their chance of being hurt is already so small as to be disregarded, and even though they nonchalantly face much greater risks every day. Some see this a evidence that models that assume rational economic behavior in all instances are incomplete at best and at worst examples of foolish intellectual pride and blind faith in the cosmos of rationality. Or perhaps it is not the assumption of rationality that is flawed, but the implementation of it: people may misunderstand basic facts that lead their calculations of rationality to false conclusions.