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The impact of the correlation between health expenditure and survival probability on the demand for insurance

Listed author(s):
  • Zhao, Kai
Registered author(s):

This paper studies the effects of health shocks on the demand for health insurance and annuities, along with precautionary saving in a dynamic life-cycle model. I argue that when the health shock can simultaneously increase health expenses and reduce longevity, rational agents would neither fully insure their uncertain health expenses nor fully annuitize their wealth because the correlation between health expenses and longevity provides a self-insurance channel for both uncertainties. That is, when the agent is hit by a health shock (which simultaneously increases health expenses and reduces longevity), she can use the resources originally saved for consumption in the reduced period of life to pay for the increased health expenses. Since the two uncertainties partially offset each other, the precautionary saving generated in the model should be smaller than in a standard model without the correlation between health expenses and longevity. In a quantitative life-cycle model calibrated using the Medical Expenditure Panel Survey dataset, I find that the health expenses are highly correlated with the survival probabilities, and this correlation significantly reduces the demand for actuarially fair health insurance, while its impact on the demand for annuities and precautionary saving is relatively small.

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File URL: http://www.sciencedirect.com/science/article/pii/S0014292115000045
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Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 75 (2015)
Issue (Month): C ()
Pages: 98-111

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Handle: RePEc:eee:eecrev:v:75:y:2015:i:c:p:98-111
DOI: 10.1016/j.euroecorev.2015.01.003
Contact details of provider: Web page: http://www.elsevier.com/locate/eer

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  1. Karen Kopecky & Tatyana Koreshkova, 2009. "The Impact of Medical and Nursing Home Expenses and Social Insurance Policies on Savings and Inequality," Working Papers 09006, Concordia University, Department of Economics.
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  9. Glenn R. Hubbard & Jonathan Skinner & Stephen P. Zeldes, "undated". "Precautionary Saving and Social Insurance," Rodney L. White Center for Financial Research Working Papers 03-95, Wharton School Rodney L. White Center for Financial Research.
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  12. Kai Zhao, 2016. "Social Insurance, Private Health Insurance and Individual Welfare," Working papers 2016-01, University of Connecticut, Department of Economics.
  13. Davies, James B, 1981. "Uncertain Lifetime, Consumption, and Dissaving in Retirement," Journal of Political Economy, University of Chicago Press, vol. 89(3), pages 561-577, June.
  14. Tauchen, George, 1986. "Finite state markov-chain approximations to univariate and vector autoregressions," Economics Letters, Elsevier, vol. 20(2), pages 177-181.
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  16. Pauly, Mark V, 1990. "The Rational Nonpurchase of Long-term-Care Insurance," Journal of Political Economy, University of Chicago Press, vol. 98(1), pages 153-168, February.
  17. Jonathan Gruber, 2008. "Covering the Uninsured in the United States," Journal of Economic Literature, American Economic Association, vol. 46(3), pages 571-606, September.
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