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

50 Pages Posted: 10 Mar 2012 Last revised: 29 May 2023

See all articles by Hanming Fang

Hanming Fang

University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER)

Edward Kung

Independent

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Date Written: March 2012

Abstract

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 i.i.d choice specific shocks, particularly when policyholders are relatively young. But as the remaining policyholders get older, the role of such i.i.d. 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.

Suggested Citation

Fang, Hanming and Kung, Edward, Why Do Life Insurance Policyholders Lapse? The Roles of Income, Health and Bequest Motive Shocks (March 2012). NBER Working Paper No. w17899, Available at SSRN: https://ssrn.com/abstract=2019398

Hanming Fang (Contact Author)

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Edward Kung

Independent

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