Insurance-Linked Lotto

Recent empirical and experimental research has well documented that an individual's willingness to purchase insurance is much lower than the level predicted by the traditional expected utility model. To increase the demand for insurance, this paper proposes a new tool of government intervention: an insurance-linked lotto. The proposed lotto is independent of the occurrence of the insurable risk, but the probability of winning the prize or the prize itself is positively correlated with the insurance coverage. We show that when an individual's preferences are characterized by rank dependent expected utility, the insurance-linked lotto could enhance the equilibrium demand for insurance and improve individual welfare as well. The above findings could be sustained in both cases where the government's objective is to maximize the rank dependent expected utility of the individual and the government evaluates wellbeing by adopting the expected utility framework.