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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 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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Publication status: published as Hendel, Igal and Alessandro Lizzeri. "The Role Of Commitment In Dynamic Contracts: Evidence From Life Insurance," Quarterly Journal of Economics, 2003, v118(1,Feb), 299-327.
Handle: RePEc:nbr:nberwo:7470

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  1. Milton Harris & Bengt Holmstrom, 1981. "A Theory of Wage Dynamics," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 488, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
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