Working Paper: NBER ID: w17899
Authors: Hanming Fang; Edward Kung
Abstract: Previous research has shown that the reasons for lapsation have important implications regarding the effects of the emerging life settlement market on consumer welfare. We present and empirically implement a dynamic discrete choice model of life insurance decisions to assess the importance of various factors in explaining life insurance lapsations. In order to explain some key features in the data, our model incorporates serially correlated unobservable state variables which we deal with using posterior distributions of the unobservables simulated from Sequential Monte Carlo (SMC) method. We estimate the model using the life insurance holding information from the Health and Retirement Study (HRS) data. Counterfactual simulations using the estimates of our model suggest that a large fraction of life insurance lapsations are driven by i.i.d choice specific shocks, particularly when policyholders are relatively young. But as the remaining policyholders get older, the role of such i.i.d. shocks gets smaller, and more of their lapsations are driven either by income, health or bequest motive shocks. Income and health shocks are relatively more important than bequest motive shocks in explaining lapsations when policyholders are young, but as they age, the bequest motive shocks play a more important role. We also suggest the implications of these findings regarding the effects of the emerging life settlement market on consumer welfare.
Keywords: life insurance; lapsation; income shocks; health shocks; bequest motives
JEL Codes: G22; H31; L11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| iid choice-specific shocks (F44) | lapsation (Y60) |
| income shocks (J65) | lapsation (Y60) |
| health shocks (I12) | lapsation (Y60) |
| bequest motive shocks (D15) | lapsation (Y60) |
| age (J14) | influence of iid shocks on lapsation (C41) |
| age (J14) | influence of income shocks on lapsation (G52) |
| age (J14) | influence of health shocks on lapsation (G52) |
| age (J14) | influence of bequest motive shocks on lapsation (D15) |