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The Role Of Commitment In Dynamic Contracts: Evidence From Life Insurance

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  • Igal Hendel
  • Alessandro Lizzeri

Abstract

We use data on life insurance contracts to study the properties of long-term contracts in a world where buyers cannot commit to a contract. The data are especially suited to test a theory of dynamic contracting since they include information on the entire profile of future premiums. All the patterns in the data fit the theoretical predictions of a model with symmetric learning and one-sided commitment à la Harris and Holmstom. The lack of commitment by consumers shapes contracts in the way predicted by the theory: all contracts involve front-loading (prepayment) of premiums. Front-loading generates a partial lock-in of consumers; more front-loading is associated with lower lapsation. Moreover, contracts that are more front-loaded have a lower present value of premiums over the period of coverage. This is consistent with the idea that front-loading enhances consumer commitment and that more front-loaded contracts retain better risk pools. © 2001 the President and Fellows of Harvard College and the Massachusetts Institute of Technology

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Bibliographic Info

Article provided by MIT Press in its journal The Quarterly Journal of Economics.

Volume (Year): 118 (2003)
Issue (Month): 1 (February)
Pages: 299-327

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Handle: RePEc:tpr:qjecon:v:118:y:2003:i:1:p:299-327

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Web page: http://mitpress.mit.edu/journals/

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  1. John Cawley & Tomas Philipson, 1997. "An Empirical Examination of Information Barriers to Trade inInsurance," University of Chicago - George G. Stigler Center for Study of Economy and State 132, Chicago - Center for Study of Economy and State.
  2. Diamond, Peter, 1992. "Organizing the Health Insurance Market," Econometrica, Econometric Society, vol. 60(6), pages 1233-54, November.
  3. Dionne, G. & Doherty, N., 1991. "Adverse Selection, Commitment and Renegotiation : Extention to and Evidence From Insurance Markets," Cahiers de recherche 9134, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
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  6. Pierre-Andre Chiappori & Bernard Salanie & Julie Valentin, 1999. "Early Starters versus Late Beginners," Journal of Political Economy, University of Chicago Press, vol. 107(4), pages 731-760, August.
  7. Fudenberg, Drew & Holmstrom, Bengt & Milgrom, Paul, 1990. "Short-term contracts and long-term agency relationships," Journal of Economic Theory, Elsevier, vol. 51(1), pages 1-31, June.
  8. Cochrane, John H, 1995. "Time-Consistent Health Insurance," Journal of Political Economy, University of Chicago Press, vol. 103(3), pages 445-73, June.
  9. Villeneuve, Bertrand, 2000. "Life Insurance," Economics Papers from University Paris Dauphine 123456789/5369, Paris Dauphine University.
  10. Benjamin M. Friedman & Mark Warshawsky, 1990. "The Cost of Annuities: Implications for Saving Behavior and Bequests," NBER Working Papers 1682, National Bureau of Economic Research, Inc.
  11. Dionne, G. & Doherty, N., 1991. "Adverse Selection in Insurance Markets: a Selective Survey," Cahiers de recherche 9105, Universite de Montreal, Departement de sciences economiques.
  12. David M. Cutler, 1993. "Why Doesn't the Market Fully Insure Long-Term Care?," NBER Working Papers 4301, National Bureau of Economic Research, Inc.
  13. Pauly, Mark V & Kunreuther, Howard & Hirth, Richard, 1995. "Guaranteed Renewability in Insurance," Journal of Risk and Uncertainty, Springer, vol. 10(2), pages 143-56, March.
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