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The Role of Commitment in Dynamic Contracts: Evidence from Life Insurance

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Author Info
Igal Hendel
Alessandro Lizzeri

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Abstract

We look at the life insurance industry to study the properties of long term contracts in a world where consumers cannot commit to a contract. The main issue is how contracts are designed to deal with classification risk. We present a model that captures the main features of this industry. The data is especially suited for a test of the theory since it includes information on the entire profile of future premiums. The lack of commitment by consumers shapes contracts in the way predicted by the theory. All types of contracts involve front-loading. This generates a partial lock-in of consumers. 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 more front-loaded contracts retain better risk pools. The estimates suggest that classification risk is almost completely insured by long term level-premium contracts.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7470.

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Date of creation: Jan 2000
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Handle: RePEc:nbr:nberwo:7470

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L0 - Industrial Organization - - General
D4 - Microeconomics - - Market Structure and Pricing

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Dionne, Georges & Doherty, Neil A, 1994. "Adverse Selection, Commitment, and Renegotiation: Extension to and Evidence from Insurance Markets," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 209-35, April. [Downloadable!] (restricted)
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  2. Dionne, G. & Doherty, N., 1991. "Adverse Selection in Insurance Markets: a Selective Survey," Cahiers de recherche 9105, Universite de Montreal, Departement de sciences economiques.
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  3. Kevin J. Murphy, 1986. "Incentives, Learning, and Compensation: A Theoretical and Empirical Investigation of Managerial Labor Contracts," RAND Journal of Economics, The RAND Corporation, vol. 17(1), pages 59-76, Spring. [Downloadable!] (restricted)
  4. David M. Cutler, 1993. "Why Doesn't the Market Fully Insure Long-Term Care?," NBER Working Papers 4301, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  5. Diamond, Peter, 1992. "Organizing the Health Insurance Market," Econometrica, Econometric Society, vol. 60(6), pages 1233-54, November. [Downloadable!] (restricted)
  6. John Cawley & Tomas Philipson, 1996. "An Empirical Examination of Information Barriers to Trade in Insurance," NBER Working Papers 5669, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. 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. [Downloadable!] (restricted)
  8. Harris, Milton & Holstrom, Bengt, 1982. "A Theory of Wage Dynamics," Review of Economic Studies, Blackwell Publishing, vol. 49(3), pages 315-33, July. [Downloadable!] (restricted)
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  9. Chiappori, P.A. & Macho, I. & Rey, p. & Salanie, B., 1994. "Repeated Moral Hazard: The Role of Memory, Commitment, and the Acces to Credit Markets," Papers 06, Laval - Laboratoire Econometrie.
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  10. 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.
  11. 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. [Downloadable!] (restricted)
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  12. Cochrane, John H, 1995. "Time-Consistent Health Insurance," Journal of Political Economy, University of Chicago Press, vol. 103(3), pages 445-73, June. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Pau Olivella & Marcos Vera-Hernandez, 2006. "Testing for adverse selection into private medical insurance," IFS Working Papers W06/02, Institute for Fiscal Studies. [Downloadable!]
  2. J. H. Abbring & P.-A. Chiappori & J. J. Heckman & J. Pinquet, 2002. "Testing for Moral Hazard on Dynamic Insurance Data," THEMA Working Papers 2002-24, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise. [Downloadable!]
  3. Alma Cohen & Liran Einav, 2005. "Estimating Risk Preferences from Deductible Choice," NBER Working Papers 11461, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Volker Meier, 2003. "Efficient Transfer of Aging Provisions in Private Health Insurance," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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  5. M. Dahchour & G. Dionne, 2002. "Pricing of Automobile Insurance Under Asymmetric Information : a Study on Panel Data," THEMA Working Papers 2002-12, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise. [Downloadable!]
  6. Dionne, G. & Michaud, P.C. & Dahchour, M., 2004. "Separating moral hazard from adverse selection in automobile insurance : longitudinal evidence from France," Discussion Paper 79, Tilburg University, Center for Economic Research. [Downloadable!]
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  7. Marc Pomp & M. Bijlsma & Machiel van Dijk & Michiel van Leuvensteijn & C. Zonderland, 2005. "Competition in markets for life insurance," CPB Documents 96, CPB Netherlands Bureau for Economic Policy Analysis. [Downloadable!]
  8. Alma Cohen, 2008. "Asymmetric Learning in Repeated Contracting: An Empirical Study," NBER Working Papers 13752, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  9. Marco Battaglini, 2003. "Long-Term Contracting with Markovian Consumers," Theory workshop papers 505798000000000048, UCLA Department of Economics. [Downloadable!]
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  10. Amy Finkelstein & Kathleen McGarry & Amir Sufi, 2005. "Dynamic Inefficiencies in Insurance Markets: Evidence from long-term care insurance," NBER Working Papers 11039, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  11. Chiappori, Pierre Andre & Salanie, Bernard, 2002. "Testing Contract Theory: A Survey of Some Recent Work," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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  12. Jay H. Hong & Jose-Victor Rios-Rull, 2004. "Life insurance and household consumption," Working Papers 04-10, Federal Reserve Bank of Philadelphia. [Downloadable!]
  13. Grönqvist, Erik, 2004. "Information Updating and Insurance Dropout: Evidence from Dental Insurance," Working Paper Series in Economics and Finance 576, Stockholm School of Economics. [Downloadable!]
  14. Amy Finkelstein & Kathleen McGarry & Amir Sufi, 2005. "Dynamic Inefficiencies in Insurance Markets: Evidence from Long-Term Care Insurance," American Economic Review, American Economic Association, vol. 95(2), pages 224-228, May. [Downloadable!]
  15. Wenan Fei & Claude Fluet & Harris Schlesinger, 2008. "Uncertain Bequest Needs and Long-Term Insurance Contracts," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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  16. Hanming Fang & Alessandro Gavazza, 2007. "Dynamic Inefficiencies in Employment-Based Health Insurance System Theory and Evidence," NBER Working Papers 13371, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  17. Malmendier, Ulrike M. & Della Vigna, Stefano, 2003. "Contract Design and Self Control: Theory and Evidence," Research Papers 1801, Stanford University, Graduate School of Business. [Downloadable!]
  18. Baumann, Florian & Meier, Volker & Werding, Martin, 2004. "Transferable Ageing Provisions in Individual Health Insurance Contracts," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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  19. Michael Hoy & Michael Ruse, 2008. "“No Solution to This Dilemma Exists”: Discrimination, Insurance, and the Human Genome Project," Working Papers 0808, University of Guelph, Department of Economics. [Downloadable!]
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