Narrow Framing and Life Insurance
Life insurance is a large yet poorly understood industry. A final death benefit is not paid for a majority of policies. Insurers make money on customers that lapse their policies and lose money on customers that keep their coverage. Policy loads are inverted relative to the dynamic pattern consistent with reclassification risk insurance. As an industry, insurers lobby to ban secondary markets despite the liquidity provided. These (and other) stylized facts cannot easily be explained by information problems alone. We demonstrate that a simple model of narrow framing, where consumers do not fully account for their need for future liquidity when purchasing insurance, offers a simple and unified explanation.
We thank Roland Bénabou, Ulrich Doraszelski, Kfir Eliaz, Hanming Fang, Matthew Rabin, Paul Siegert, Jean Tirole, and Dan Sacks for providing comments. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.