Life insurance and life settlement markets with overconfident policyholders

Hanming Fang and Zenan Wu

Journal of Economic Theory, 2020, vol. 189, issue C

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. In our model, policyholders may lapse their life insurance policies when they lose their bequest motives; however, they are overconfident in the sense that they may underestimate the probability of losing their bequest motives. We show that in the competitive equilibrium without life settlement, overconfident consumers will buy life insurance contracts with “too much” reclassification risk insurance for later periods. The life settlement market can impose a limit on the extent to which primary insurers can exploit overconfident consumers. We show that the life settlement market 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. Our result is robust to alternative specifications where (i) insurers cannot observe the subjective or objective probability that policyholders will lose their bequest motives; (ii) insurers can include health-contingent cash surrender values (CSVs) in the life insurance contract; and (iii) policyholders underestimate their future mortality risk.

Keywords: Life insurance; Secondary market; Overconfidence; Intertemporal elasticity of substitution (search for similar items in EconPapers)
JEL-codes: D03 D86 G22 L11 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Related works:
Working Paper: Life Insurance and Life Settlement Markets with Overconfident Policyholders (2017)
Working Paper: Life Insurance and Life Settlement Markets with Overconfident Policyholders (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:189:y:2020:i:c:s0022053120300879

DOI: 10.1016/j.jet.2020.105093

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