Topics in Risk and Insurance
Friday, Jan. 5, 2018 8:00 AM - 10:00 AM
- Chair: Casey Rothschild, Wellesley College
Optimal Insurance Demand when Contract Nonperformance Risk is Perceived as Ambiguous
AbstractWe study the optimal insurance demand of a risk- and ambiguity-averse consumer if contract nonperformance risk is perceived as ambiguous. We find that the consumer's optimal insurance demand is lower compared to a situation without ambiguity and that his degree of ambiguity aversion is negatively associated with the optimal level of coverage. We also determine sufficient conditions for biased beliefs or greater ambiguity to reduce the optimal demand for insurance and discuss wealth effects. Finally, we scrutinize several alternative model specifications to demonstrate the robustness of our main findings and discuss implications of our findings.
Optimal Social Security Claiming Behavior under Lump Sum Incentives: Theory and Evidence
AbstractPeople who delay claiming Social Security receive higher lifelong benefits upon retirement. We survey individuals on their willingness to delay claiming later, if they could receive a lump sum in lieu of a higher annuity payment. Using a moment-matching approach, we calibrate a lifecycle model tracking observed
claiming patterns under current rules and predict optimal claiming outcomes under the lump sum approach. Our model correctly predicts that early claimers under current rules would delay claiming most when offered actuarially fair lump sums, and for lump sums worth 87% as much, claiming ages would still be higher than at present.
Sunk Costs and Screening: Two-part Tariffs in Life Insurance
AbstractThere are large, upfront, fixed costs to writing a life insurance policy. Both agent commission and direct underwriting costs (e.g., fees for physicals and blood tests) are fully paid a few years into contracts that can last 10-30 years. Because of these upfront costs, insurers can actually lose money on policies when the consumer lapses early into the contract, even if no death benefit is ever paid out. Thus, to properly price contracts, insurers must estimate lapse risks. However, consumers will often have private knowledge of their lapse likelihood, leading to adverse selection. We develop a model of insurance pricing under heterogeneous lapse rates with asymmetric information about lapse likelihood within the context of an optional two-part tariff as a screening device for future policyholder behavior. We then test for consumer self-selection using detailed, policy-level data on life insurance backdating (a common practice that resembles a two-part tariff). We are able to identify, through a control function approach, the information about lapse risk a consumer reveals when they choose to backdate. Our contribution to the literature is twofold: we are the first to consider life insurance lapsing as a form of adverse selection; we also explore, both theoretically and empirically, the role of optional two-part tariffs as a screening mechanism using life insurance backdating as our primary example. We find that consumers who are less likely to lapse self-select into the two-part tariff pricing structure and also document consumer behavior consistent with sunk cost fallacy.
- D8 - Information, Knowledge, and Uncertainty
- G2 - Financial Institutions and Services