The Demand for Health Insurance: A Preference for Certain Losses or Desire for Income Transfers If Ill?

Two alternative interpretations of the demand for insurance can be derived from the basic insurance model: (1) insurance is a preference for certain losses over uncertain ones of the same expected magnitude, or (2) insurance is a demand for an income transfer if the bad state of the world occurs. Although the former represents convention, many empirical studies show that people actually prefer uncertain losses to certain ones of the same expected magnitude. This paper presents the case that the second interpretation is more generally applicable and, with regard to health insurance, does not lead to the misleading empirical conclusions and misinformed public policy that the first, conventional interpretation has generated. [