The representative heuristic and catastrophe-related risk behaviors

Building on the work by Volkman-Wise Journal of Risk and Uncertainty, 51, 267–290 (2015) and Dumm et al. (The Geneva Risk and Insurance Review, 42, 117–139 (2017), we examine behavioral aspects of risk through the representative heuristic’s impact on catastrophe-related probability assessment and insurance demand of Florida homeowners. The representative heuristic models individuals as underweighting prior probabilities and overweighting posterior probabilities, thereby overweighting the probability of a loss from a disaster after a disaster occurs. Using data for homeowners’ insurance purchases through Florida’s residual market over a time period (2003-2008) that includes a sub-period of many losses (2004-2005) and sub-period of few catastrophic losses (2003, 2006-2008), we find increases in demand at the individual policyholder level for coverage following losses. Also consistent with the representative heuristic, we find that the effect attenuates as the losses fade from memory. That is, the effect of losses on demand is much higher for more recent losses. We also are able to parameterize the representative heuristic model showing that individual policy holders overweight the probability of another catastrophic event occurring by nearly 50%, after one has occurred.