Academic journal article Journal of Risk and Insurance

The Effects of Household Characteristics on Demand for Insurance: A Tobit Analysis

Academic journal article Journal of Risk and Insurance

The Effects of Household Characteristics on Demand for Insurance: A Tobit Analysis

Article excerpt


The purchase of a comprehensive insurance package is a complex process. Consumers evaluate their financial needs in order to select various types of insurance. Emerging issues in the area of insurance suggest the need for examining the demand for total insurance. For some, life or health insurance premiums may be subsidized by an employer. Some states have made vehicle insurance mandatory. Also, rising health care costs have brought about higher health insurance premiums, as well as proposals for a national health care system. These and other issues make choosing a total insurance package a perplexing process for consumers. In examining total insurance needs, insurers and government policy-makers can better understand the limitations or opportunities involved in fulfilling the overall risk-reducing needs of a household. Thus, understanding the household's behavior concerning the desired amounts of various types of insurance can play an important role in anticipating both private and public insurance demands.

This article augments the empirical literature on insurance demand by examining the impacts of selected economic and social factors on the purchase of insurance. To account for the fact that not every household purchases insurance, a Tobit procedure is used to estimate marginal impacts on purchasers, as well as the changes in the probability of purchasing insurance.

Insurance Consumption Behavior

Babbel (1985) found that new purchases of whole life insurance are inversely related to changes in a real price index. Mossin (1968) showed that a risk-averse utility maximizer will obtain something less than full insurance coverage if the insurance premium is actuarially unfavorable. Briys and Louberge (1985), however, reconciled apparent empirical contradictions to Mossin's price sensitivity theory by suggesting that consumers often purchase insurance without being fully informed. Additional studies found that income, net worth (Hammond, Houston, and Melander, 1967), and working wives (Duker, 1969) influence expenditures on insurance.

In finance theory, consumers diversify assets as a means of spreading risk. Demand for insurance arises from incomplete diversification. Under utility maximization, portfolio theory suggests that consumers evaluate several factors simultaneously in their insurance purchasing decision. Doherty (1984) showed that efficient levels of insurance increase with the level of insurable risk and with the weight of the asset in the portfolio. Mayers and Smith (1983) demonstrated that the demand for insurance contracts is determined simultaneously with the demand for other assets in the portfolio. Consumers' expected utility from various assets motivates them to diversify.

Ehrlich and Becket (1972) showed that traditional economic consumer behavior theory can be combined with expected utility within the context of the "state preference" approach to behavior under uncertainty. Although market insurance redistributes income toward the less well-endowed states, the consumer's need for insurance is no different from the consumer's need for any other good or service. They show that the equimarginal principle of consumer behavior is applicable to the purchase of insurance. These consumption behavior studies motivate the development of the total insurance demand model used for this study.


Mayers and Smith (1983) presented a version of the classical economic utility model in which utility is a function of end-of-period wealth (W) and variance of end-of-period wealth ([[Sigma].sup.2]W):

[U.sub.l,i] = [U.sub.i] ([W.sub.i], [[Sigma].sup.2][W.sub.i]). (1)

Wealth for individual i is defined as a linear composite of all marketable assets (MA), all nonmarketable assets (NA), debt (D), and a vector of different pay-outs for the insured events ([Phi]I):

[W.sub.i] = M[A.sub.i] + N[A.sub.i] - r[D.sub.i] + [summation of][[Phi]. …

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