Risk misperceptions and selection in insurance markets: An application to demand for cancer insurance

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We test for the influence of optimism on selection in a hypothetical cancer-insurance market using a survey of 474 subjects. We elicit perceptions of baseline cancer risk and control efficacy and combine these with subject-specific cancer risks predicted by the Harvard Cancer Risk Index to develop measures of baseline and control optimism. Following Fang, Keane, and Silverman (), we hypothesize that a variable may lead to advantageous selection if it is positively correlated with both prevention effort and demand for insurance. We find evidence of selection from both baseline and control optimism, but little evidence of selection from cognitive ability and risk aversion. We then estimate a model that allows us to classify subjects according to their excess risk-reducing effort and excess insurance uptake that occurs solely because of baseline and control optimism. We find subjects who overinsure relative to a subject with accurate risk beliefs are likely to have lower expected treatment costs, ceteris paribus. This indicates that on net, baseline and control optimism leads to advantageous selection in our sample. © 2016 The Journal of Risk and Insurance.

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