Balancing the desire for privacy against the desire to hedge risk

Abstract

An individual's desire to hedge risks, as implied by risk aversion, is accepted as a normative paradigm and documented as valid descriptively. Insurance markets satisfy this desire, wherein the individual's aversion to bear risk allows firms to demand a markup on the expected value of the insured loss. Insurance firms incrementally introduce digital monitoring technology into their policies, making policyholder's behavior transparent. We analyze the implications of such transparency insurance contracts for willingness to pay in a framed behavioral experiment and find that the loss of privacy in such contracts marginalizes the potential profits that insurers could earn on their policies. In particular, our results suggest that the reduction in willingness to pay from introducing digital monitoring is in the range of 25–50% of the expected loss. While an absolute as opposed to a relative monetary valuation concept of privacy appears more likely to explain our data, we cannot clearly confirm this conjecture empirically. Heterogeneous treatment effects for risk preferences are suggestive for increasing utility losses from transparency policies with increasing risk aversion but we also observe indications of nonlinearities in this relationship. Probability misperception is a salient characteristic of our experimental population, suggesting that profitability is less threatened under low-frequency risks as opposed to high-frequency risks.