Why Do Life Insurance Policyholders Lapse? The Roles of Income, Health and Bequest Motive Shocks

Previous research has shown that the reasons for lapsation have important implications regarding the effects of the emerging life settlement market on consumer welfare. We present and empirically implement a dynamic discrete choice model of life insurance decisions to assess the importance of variou...

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Bibliographic Details
Published in:NBER Working Paper Series 2012-03, p.17899
Main Authors: Fang, Hanming, Kung, Edward
Format: Article
Language:English
Subjects:
Cash surrender value
Councils
Decision analysis
Econometrics
Economic theory
Economics
Insurance coverage
Insurance industry
Insurance policies
Insurance premiums
Life insurance
Life settlement
Marketing
Monte Carlo simulation
Policyholders
Roles
Studies
Universal life
Welfare economics
Whole life
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Summary:Previous research has shown that the reasons for lapsation have important implications regarding the effects of the emerging life settlement market on consumer welfare. We present and empirically implement a dynamic discrete choice model of life insurance decisions to assess the importance of various factors in explaining life insurance lapsations. In order to explain some key features in the data, our model incorporates serially correlated unobservable state variables which we deal with using posterior distributions of the unobservables simulated from Sequential Monte Carlo (SMC) method. We estimate the model using the life insurance holding information from the Health and Retirement Study (HRS) data. Counterfactual simulations using the estimates of our model suggest that a large fraction of life insurance lapsations are driven by iid choice specific shocks, particularly when policyholders are relatively young. But as the remaining policyholders get older, the role of such iid shocks gets smaller, and more of their lapsations are driven either by income, health or bequest motive shocks. Income and health shocks are relatively more important than bequest motive shocks in explaining lapsations when policyholders are young, but as they age, the bequest motive shocks play a more important role. We also suggest the implications of these findings regarding the effects of the emerging life settlement market on consumer welfare.
ISSN:0898-2937
DOI:10.3386/w17899