Habit Formation and the Demand for Insurance

This article models consumption and insurance decisions in a continuous-time, finite-horizon setting. We allow the consumer to acquire a "taste for the good life" by making current preferences for consumption dependent upon the individual's past consumption. The optimal consumption pa...

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Bibliographic Details
Published in:The Journal of risk and insurance 1996-03, Vol.63 (1), p.111-119
Main Authors: Ben-Arab, Mounira, Briys, Eric, Schlesinger, Harris
Format: Article
Language:English
Subjects:
Consumer behavior
Consumer psychology
Consumer tastes
Decision making
Demand
Full coverage
Habitual behavior
Insurance
Insurance coverage
Insurance deductibles
Insurance premiums
Purchasing
Risk aversion
Shorter Articles
Studies
Utility functions
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Summary:This article models consumption and insurance decisions in a continuous-time, finite-horizon setting. We allow the consumer to acquire a "taste for the good life" by making current preferences for consumption dependent upon the individual's past consumption. The optimal consumption path is smoother and the optimal level of insurance greater in this setting than they are in an identical model without habit formation. Moreover, the optimal level of insurance increases over the planning horizon, approaching full coverage in the limit. These results help to explain the observed phenomenon of individuals' over-purchasing insurance, such as a propensity for low deductibles.
ISSN:0022-4367
1539-6975
DOI:10.2307/253519