Ambiguity and underwriter decision processes

Abstract

This paper provides empirical evidence that risk and ambiguity affect underwriters' decisions on pricing insurance. A field study of primary-insurance underwriters in a random sample of commercial property-and-casualty insurance companies reveals that premiums are significantly higher for risks when there is either ambiguity regarding the probability of a particular event occurring and/or uncertainty about the magnitude of the resulting loss. The paper suggests economic and organizational rationales for this behaviour and offers several explanations as to why insurers in a competitive market can charge higher prices for ambiguous risks which promise to yield excess profits in the long run.