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Topics in Risk and Insurance

Paper Session

Friday, Jan. 5, 2018 8:00 AM - 10:00 AM

Marriott Philadelphia Downtown, Meeting Room 405
Hosted By: American Risk and Insurance Association & American Economic Association
  • Chair: Casey Rothschild, Wellesley College

The Dark Side of Liquid Bonds in Fire Sales

Maria Chaderina
,
Vienna University of Economics and Business and Vienna Graduate School of Finance
Alexander Muermann
,
Vienna University of Economics and Business and Vienna Graduate School of Finance
Christoph Scheuch
,
Vienna Graduate School of Finance

Abstract

We investigate which bonds institutional investors sell in fire sales. We find that these are mostly bonds that were trading in liquid markets before the fire sale, and that they are sold by other institutions as well. Somewhat surprisingly, the price impacts in these markets are higher than in bonds that were trading in less liquid markets before the fire sale, but are also liquidated during fire sales. It appears as if liquid bonds in fire-sales exhibit larger price impacts than less liquid bonds. We argue this is because institutions fail to fully account for the effect of selling common bonds on other market participants. Controlling for commonality of bonds, we find that liquid bonds have smaller price impacts in fire sales. This result matters for the measurement of systemic risk: the commonality of liquid bonds exacerbates fire sales losses, as they are sold more in fire sales. Measures of portfolio similarity should thus overweight liquid bonds overlap, not underweight it.

Optimal Insurance Demand when Contract Nonperformance Risk is Perceived as Ambiguous

Richard Peter
,
University of Iowa
Jie Ying
,
University of Iowa

Abstract

We 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

Raimond Maurer
,
Goethe University Frankfurt
Olivia S. Mitchell
,
University of Pennsylvania
Ralph Rogalla
,
St. John's University
Tatjana Schimetschek
,
Goethe University Frankfurt

Abstract

People 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

James Carson
,
University of Georgia
Cameron Ellis
,
Temple University
Robert Hoyt
,
University of Georgia
Krzysztof Ostaszewski
,
Illinois State University

Abstract

There 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.
Discussant(s)
Richard Butler
,
Brigham Young University
James Carson
,
University of Georgia
Richard Peter
,
University of Iowa
Alexander Muermann
,
Vienna University of Economics and Business and Vienna Graduate School of Finance
JEL Classifications
  • D8 - Information, Knowledge, and Uncertainty
  • G2 - Financial Institutions and Services