The Role of Commitment in Dynamic Contracts: Evidence from Life Insurance

Igal Hendel and Alessandro Lizzeri

The Quarterly Journal of Economics, 2003, vol. 118, issue 1, 299-328

Abstract: We use data on life insurance contracts to study the properties of long-term contracts in a world where buyers cannot commit to a contract. The data are especially suited to test a theory of dynamic contracting since they include information on the entire profile of future premiums. All the patterns in the data fit the theoretical predictions of a model with symmetric learning and one-sided commitment à la Harris and Holmstom. The lack of commitment by consumers shapes contracts in the way predicted by the theory: all contracts involve front-loading (prepayment) of premiums. Front-loading generates a partial lock-in of consumers; more front-loading is associated with lower lapsation. Moreover, contracts that are more front-loaded have a lower present value of premiums over the period of coverage. This is consistent with the idea that front-loading enhances consumer commitment and that more front-loaded contracts retain better risk pools.

Date: 2003
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Working Paper: The Role of Commitment in Dynamic Contracts: Evidence from Life Insurance (2000)
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