People purchase insurance because they are:
A risk averse.
B exhibiting status quo bias.
C miscalculating their opportunity costs.
D exhibiting bounded rationality.
The correct answer and explanation is:
The correct answer is A: risk averse.
Explanation:
People generally purchase insurance because they are risk averse, meaning they prefer to avoid uncertainty and potential financial loss. Risk aversion refers to the tendency to prefer outcomes with known risks over those with unknown or high-risk outcomes. When individuals buy insurance, they are essentially transferring the risk of a potentially catastrophic event (like an accident, illness, or property damage) to the insurance company in exchange for a premium. This reduces the uncertainty and financial burden they would face if such an event occurred.
The concept of risk aversion is rooted in economics and behavioral finance. People would rather pay a smaller, predictable amount (the insurance premium) than face the possibility of a large, unpredictable expense in the event of a loss. In other words, the utility of avoiding a large loss outweighs the utility gained from the potential savings of not having to pay the insurance premium.
Insurance works as a mechanism to mitigate the financial impact of uncertain events, making it especially appealing to those who are risk-averse. It allows individuals to safeguard themselves from risks that could otherwise be financially devastating. This preference for avoiding risk explains why individuals are willing to pay for insurance, even when the probability of a claim might be relatively low.
Option B: exhibiting status quo bias is incorrect because status quo bias involves a preference for things to remain as they are, rather than actively seeking to reduce risk. Option C: miscalculating their opportunity costs and D: exhibiting bounded rationality don’t directly relate to the reason people purchase insurance. While opportunity costs and bounded rationality influence decision-making in many contexts, risk aversion is the primary motivator for insurance purchases.