Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/196910
Authors: 
Kubitza, Christian
Hofmann, Annette
Steinorth, Petra
Year of Publication: 
2019
Series/Report no.: 
ICIR Working Paper Series 34/19
Abstract: 
This paper studies insurance demand for individuals with limited financial literacy. We propose uncertainty about insurance payouts, resulting from contract complexity, as a novel channel that affects decision-making of financially illiterate individuals. Then, a trade-off between second-order (risk aversion) and third-order (prudence) risk preferences drives insurance demand. Sufficiently prudent individuals raise insurance demand upon an increase in contract complexity, while the effect is reversed for less prudent individuals. We characterize competitive market equilibria that feature complex contracts since firms face costs to reduce complexity. Based on the equilibrium analysis, we propose a monetary measure for the welfare cost of financial illiteracy and show that it is mainly driven by individuals' risk aversion. Finally, we discuss implications for regulation and consumer protection.
Subjects: 
financial literacy
insurance demand
prudence
precautionary insurance
JEL: 
D11
D81
D91
G22
Document Type: 
Working Paper
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