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Commitment versus Flexibility and Sticky Prices: Evidence from Life Insurance

Radek Paluszynski and Pei Cheng Yu

Review of Economic Dynamics, 2023, vol. 49, 99-122

Abstract: Life insurance premiums display significant rigidity in the data, on average adjusting once every 3 years by more than 10%. This contrasts with the underlying marginal cost which exhibits considerable volatility due to the movements in interest and mortality rates. We build a dynamic model where policyholders are held-up by long-term insurance contracts, resulting in a time inconsistency problem for the insurer. The optimal contract balances commitment and flexibility and takes the form of a simple cutoff rule: premiums are rigid for cost realizations smaller than the threshold, while adjustments must be large and are only possible when cost realizations exceed it. We use a calibrated version of the model to show that it matches the data and captures several aspects of premium rigidity in the cross-section and over time. (Copyright: Elsevier)

Keywords: Life insurance; Time inconsistency; Hold-up problem; Commitment; Flexibility (search for similar items in EconPapers)
JEL-codes: G22 L11 L14 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1016/j.red.2022.07.003

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