Why do life insurance policyholders lapse? The roles of income, health, and bequest motive shocks

• Published in: The Journal of risk and insurance 2021-12, Vol.88 (4), p.937-970
• Main Authors: Fang, Hanming, Kung, Edward
• Format: Article
• Language: English
• Subjects: Life insurance; life insurance lapsations; Policyholders; sequential Monte Carlo method
• ISSN: 0022-4367; 1539-6975
• DOI: 10.1111/jori.12332

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 lapsation. We estimate a model using information on life insurance holdings from the Health and Retirement Study. Counterfactual simulations using the estimates of our model suggest that a large fraction of life insurance lapsations are driven by idiosyncratic shocks, uncorrelated with health, income, and bequest motives, particularly when policyholders are relatively young. As the remaining policyholders get older, however, the role of such independent and identically distributed (i.i.d.) shocks gets smaller, and more of their lapsation is driven by income, health, or bequest motive shocks. As anticipated, income and health shocks are relatively more important than bequest motive shocks in explaining lapsation when policyholders are young, with bequest motive shocks playing a more important role as we age.