Balancing risk: the importance of insurance

Are You Playing Russian Roulette with Risk? Why Ignoring Insurance Could Cost You Everything

Theo Raines in Business & Economy June 2025 • 3 min read.

"A meta-analysis reveals the hidden factors influencing our willingness to protect against life's low-probability disasters, from cultural biases to communication failures."

We all like to think we're rational beings, carefully weighing the odds and making informed decisions. But when it comes to low-probability, high-impact risks – the kind that could wipe out your savings or even your home – our brains often play tricks on us. Why do we consistently underestimate these dangers and fail to adequately protect ourselves?

A groundbreaking meta-analysis, a study of studies, has shed light on this puzzling phenomenon. Researchers delved into a wealth of data on "contingent valuation," a method used to estimate how much people are willing to pay to insure against rare but potentially catastrophic events. Their findings reveal a complex interplay of factors that influence our perception of risk and, ultimately, our willingness to invest in insurance.

Forget simple dollars and cents; this is a deep dive into the psychology of risk, uncovering how cultural biases, communication failures, and even the way information is presented can dramatically alter our decisions. Get ready to rethink your approach to security, because the stakes are higher than you think.

The Underinsurance Puzzle: Are We Wired to Fail?

Balancing risk: the importance of insurance

The study confirms a persistent trend: people consistently undervalue insurance against low-probability, high-impact (LPHI) events. On average, individuals are willing to pay only 87% of the expected losses, revealing a significant "underinsurance" gap. This isn't just about being cheap; it's about a fundamental disconnect in how we perceive and process risk.

Expected Utility Theory (EUT), the traditional economic model, suggests that insurance decisions are driven by risk aversion. However, the low take-up of LPHI insurance challenges this assumption, suggesting that other factors are at play.

Probability Neglect: We tend to downplay risks with very low probabilities, even if the potential consequences are severe.
Cognitive Biases: Mental shortcuts and biases distort our judgment, leading to irrational decisions.
Lack of Experience: We struggle to grasp the true impact of events we haven't personally experienced.

These factors combine to create a dangerous blind spot, leaving us vulnerable to financial ruin in the face of unforeseen disasters.

Securing Your Future: Practical Steps to Overcome the Bias

The meta-analysis offers actionable insights to improve our risk assessment and insurance decisions:

About this Article -

This article was crafted using a human-AI hybrid and collaborative approach. AI assisted our team with initial drafting, research insights, identifying key questions, and image generation. Our human editors guided topic selection, defined the angle, structured the content, ensured factual accuracy and relevance, refined the tone, and conducted thorough editing to deliver helpful, high-quality information.See our About page for more information.

This article is based on research published under:

DOI-LINK: 10.1016/j.socec.2024.102181,

Title: Valuing Insurance Against Small Probability Risks: A Meta-Analysis

Subject: q-fin.rm stat.me

Authors: Selim Mankaï, Sébastien Marchand, Ngoc Ha Le

Published: 26-02-2024

Everything You Need To Know

Why do people often fail to adequately insure themselves against low-probability, high-impact (LPHI) events, even though these events could have devastating consequences?

People frequently undervalue insurance against low-probability, high-impact (LPHI) events due to a combination of psychological biases and cognitive limitations. One key factor is probability neglect, where individuals tend to downplay risks with very low probabilities, regardless of the potential severity. Cognitive biases, such as mental shortcuts that distort judgment, and a lack of personal experience with such events also contribute to this underinsurance gap. Traditional economic models like Expected Utility Theory (EUT) which suggest insurance decisions are driven by risk aversion, don't fully explain the low take-up of LPHI insurance, indicating that these psychological factors play a significant role.

What is "contingent valuation" as used in the meta-analysis, and what did it reveal about our willingness to pay for insurance against rare disasters?

"Contingent valuation" is a method used to estimate how much people are willing to pay to insure against rare but potentially catastrophic events. The meta-analysis, which studied numerous contingent valuation studies, revealed that individuals are, on average, willing to pay only 87% of the expected losses associated with these events. This significant "underinsurance" gap highlights a disconnect in how we perceive and process risk, indicating that people consistently undervalue insurance.

How do cultural biases and communication failures affect our insurance decisions regarding low-probability, high-impact (LPHI) events?

Cultural biases and communication failures can significantly impact insurance decisions related to low-probability, high-impact (LPHI) events. Cultural biases can shape our perception of risk and influence our willingness to invest in protective measures. Communication failures, such as the way information about risk is presented, can also dramatically alter decisions. If the potential consequences of LPHI events are not communicated effectively or are framed in a way that minimizes their impact, individuals may be less likely to take appropriate action and purchase insurance. This is tied to "probability neglect."

What are the practical implications of understanding probability neglect, cognitive biases, and lack of experience in the context of insurance?

Understanding probability neglect, cognitive biases, and lack of experience has several practical implications for improving risk assessment and insurance decisions. Recognizing that individuals tend to downplay low-probability risks allows for the development of communication strategies that highlight the potential consequences of LPHI events in a more impactful way. Addressing cognitive biases involves designing decision-making frameworks that help individuals overcome mental shortcuts and make more rational choices. Additionally, providing education and simulations that allow people to grasp the true impact of events they haven't personally experienced can increase their willingness to invest in insurance.

Traditional economic models like Expected Utility Theory (EUT) suggest insurance decisions are driven by risk aversion, but what does the underinsurance of low-probability, high-impact (LPHI) events tell us about the limitations of EUT?

The underinsurance of low-probability, high-impact (LPHI) events suggests that Expected Utility Theory (EUT) has limitations in explaining real-world insurance decisions. While EUT posits that individuals make rational choices based on risk aversion, the fact that people consistently undervalue insurance against rare but potentially catastrophic events indicates that other factors are at play. Psychological biases such as probability neglect, where individuals downplay risks with very low probabilities, and cognitive biases, which distort judgment, suggest that human behavior often deviates from the purely rational assumptions of EUT. This highlights the need to incorporate psychological and behavioral insights into economic models to better understand and predict insurance decisions.