Don't Lapse into Temptation: A Behavioral Explanation for Policy Surrender
36 Pages Posted: 26 Jan 2015 Last revised: 10 Mar 2017
Date Written: January 25, 2015
Abstract
Many policyholders surrender their life insurance policies early, leading to substantial monetary losses for private households. Surrender can be explained rationally if it constitutes the last resort providing liquidity in the event of an urgent need of cash. In contrast, we find clear evidence in German panel data that for more than half of all surrendered contracts investors had cheaper options available to provide the required liquidity. This finding demonstrates that policyholders exhibit bounded rationality even in important life time decisions. We provide a behavioral explanation, focusing on the role of financial literacy, individual decision heuristics, and financial advice. In particular, we show that financial literacy and financial advice can mitigate the behavioral temptation to lapse.
Keywords: Life Insurance; Behavioral Insurance; Emergency Fund Hypothesis; Financial Literacy; Financial Advice; Heuristic Decision Making
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