Life Insurance and Life Settlement Markets with Overconfident Policyholders
We analyze how the life settlement market – the secondary market for life insurance – may affect consumer welfare in a dynamic equilibrium model of life insurance with one-sided commitment and overconfident policyholders. As in Daily et al. (2008) and Fang and Kung (2010), policyholders may lapse their life insurance policies when they lose their bequest motives; but in our model the policyholders may underestimate their probability of losing their bequest motive, or be overconfident about their future mortality risks. For the case of overconfidence with respect to bequest motives, we show that in the absence of life settlement overconfident consumers may buy “too much” reclassification risk insurance for later periods in the competitive equilibrium. In contrast, when consumers are overconfident about their future mortality rates in the sense that they put too high a subjective probability on the low-mortality state, the competitive equilibrium contract in the absence of life settlement exploits the consumer bias by offering them very high face amounts only in the low-mortality state. In both cases, life settlement market can impose a discipline on the extent to which overconfident consumers can be exploited by the primary insurers. We show that life settlement may increase the equilibrium consumer welfare of overconfident consumers when they are sufficiently vulnerable in the sense that they have a sufficiently large intertemporal elasticity of substitution of consumption.
We would like to thank Douglas Bernheim, Yongmin Chen, Jiong Gong, Daniel Gottlieb, Michael Grubb, Glenn Harrison, Daniel Houser, Botond Kőszegi, Jianpei Li, Sherry Li, Jaimie Lien, Andrew Postlewaite and John Quah, as well as participants at Tsinghua Conference on Theoretical and Behavioral Economics (2015), UIBE IO and Competition Policy Workshop (2016), UNSW Superannuation Symposium (2016) for useful comments and discussions. Fang would also like to gratefully acknowledge the generous financial support from the National Science Foundation through Grant SES-0844845. Wu thanks School of Economics, Peking University for research support. All remaining errors are our own. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Hanming Fang & Zenan Wu, 2020. "Life insurance and life settlement markets with overconfident policyholders," Journal of Economic Theory, vol 189. citation courtesy of