The Impact of Health Risks on Individual Decision Making: Focusing on the Demand for Insurance and Risky Assets

Abstract

This study examines the impact of health and health risks on individuals' decision-making using a bivariate utility function, where the level of utility depends on both wealth and health. The findings are as follows, first, partial insurance may be optimal even under an actuarially fair insurance premium. Conversely, full insurance or over insurance may be optimal, even under an actuarially unfavorable premium. Second, when the utility function exhibits cross-risk vulnerability toward health, the presence of unfair health risks, independent of losses, increases the demand for insurance. Third, correlation-loving individuals reduce their investment in risky assets as health deteriorates when their preference exhibits decreasing absolute risk aversion (DARA) in wealth and absolute risk aversion (ARA) in wealth is sufficiently large. Conversely, correlation-averse individuals reduce their investment in risky assets as health deteriorates when their preference for DARA and ARA in wealth is sufficiently small. Fourth, when the utility function exhibits cross-risk vulnerability toward health, the presence of unfair health risks independent of the returns of risky assets reduces the demand for those assets.