Working Paper: NBER ID: w23286
Authors: Hanming Fang; Zenan Wu
Abstract: We analyze how the life settlement market – the secondary market for life insurance – may affect consumer welfare in a dynamic equilibrium model of life insurance with one-sided commitment and overconfident policyholders. As in Daily et al. (2008) and Fang and Kung (2010), policyholders may lapse their life insurance policies when they lose their bequest motives; but in our model the policyholders may underestimate their probability of losing their bequest motive, or be overconfident about their future mortality risks. For the case of overconfidence with respect to bequest motives, we show that in the absence of life settlement overconfident consumers may buy “too much” reclassification risk insurance for later periods in the competitive equilibrium. In contrast, when consumers are overconfident about their future mortality rates in the sense that they put too high a subjective probability on the low-mortality state, the competitive equilibrium contract in the absence of life settlement exploits the consumer bias by offering them very high face amounts only in the low-mortality state. In both cases, life settlement market can impose a discipline on the extent to which overconfident consumers can be exploited by the primary insurers. We show that life settlement may increase the equilibrium consumer welfare of overconfident consumers when they are sufficiently vulnerable in the sense that they have a sufficiently large intertemporal elasticity of substitution of consumption.
Keywords: life insurance; life settlements; overconfidence; consumer welfare
JEL Codes: D03; D86; G22; L11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| overconfidence in bequest motives (D14) | excessive reclassification risk insurance (G22) |
| underestimating the probability of losing bequest motive (D15) | excessive reclassification risk insurance (G22) |
| excessive reclassification risk insurance (G22) | negative impact on welfare (I30) |
| overly optimistic future mortality rates (J17) | exploitation of biases in insurance contracts (G52) |
| introduction of a life settlement market (G52) | discipline on insurers (G22) |
| discipline on insurers (G22) | increase in consumer welfare (D11) |
| sufficiently large intertemporal elasticity of substitution of consumption (D15) | welfare gain from life settlement market (G52) |