Life Insurance and Life Settlement Markets with Overconfident Policyholders

Hanming Fang and Zenan Wu

No 23286, NBER Working Papers from National Bureau of Economic Research, Inc

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.

JEL-codes: D03 D86 G22 L11 (search for similar items in EconPapers)
Date: 2017-03
New Economics Papers: this item is included in nep-dge, nep-ias, nep-mic, nep-mkt and nep-rmg
Note: IO PE
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Citations: View citations in EconPapers (1)

Published as Hanming Fang & Zenan Wu, 2020. "Life insurance and life settlement markets with overconfident policyholders," Journal of Economic Theory, vol 189.

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Journal Article: Life insurance and life settlement markets with overconfident policyholders (2020)
Working Paper: Life Insurance and Life Settlement Markets with Overconfident Policyholders (2017)
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