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

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  • Zhao, Kai

Abstract

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.

Suggested Citation

  • Zhao, Kai, 2015. "The impact of the correlation between health expenditure and survival probability on the demand for insurance," European Economic Review, Elsevier, vol. 75(C), pages 98-111.
  • Handle: RePEc:eee:eecrev:v:75:y:2015:i:c:p:98-111
    DOI: 10.1016/j.euroecorev.2015.01.003
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    References listed on IDEAS

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    1. Michael D. Hurd & Daniel McFadden & Angela Merrill, 2001. "Predictors of Mortality among the Elderly," NBER Chapters,in: Themes in the Economics of Aging, pages 171-198 National Bureau of Economic Research, Inc.
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    8. Pashchenko, Svetlana, 2013. "Accounting for non-annuitization," Journal of Public Economics, Elsevier, vol. 98(C), pages 53-67.
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    11. 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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    13. Brown, Jeffrey R. & Finkelstein, Amy, 2007. "Why is the market for long-term care insurance so small?," Journal of Public Economics, Elsevier, vol. 91(10), pages 1967-1991, November.
    14. Luisa Fuster & Ayşe İmrohoroğlu & Selahattin İmrohoroğlu, 2007. "Elimination of Social Security in a Dynastic Framework," Review of Economic Studies, Oxford University Press, vol. 74(1), pages 113-145.
    15. repec:eee:dyncon:v:78:y:2017:i:c:p:102-117 is not listed on IDEAS
    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. Lee Lockwood, 2012. "Bequest Motives and the Annuity Puzzle," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 15(2), pages 226-243, April.
    18. Zhao, Kai, 2017. "Social insurance, private health insurance and individual welfare," Journal of Economic Dynamics and Control, Elsevier, vol. 78(C), pages 102-117.
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    Citations

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    Cited by:

    1. Ayşe İmrohoroğlu & Kai Zhao, 2017. "The Chinese Saving Rate: Long-Term Care Risks, Family Insurance, and Demographics," Working papers 2017-17, University of Connecticut, Department of Economics.
    2. repec:bpj:jossai:v:4:y:2016:i:3:p:235-243:n:4 is not listed on IDEAS
    3. repec:eee:dyncon:v:79:y:2017:i:c:p:126-153 is not listed on IDEAS
    4. Ferreira, Pedro Cavalcanti & Gomes, Diego B.P., 2017. "Health care reform or more affordable health care?," Journal of Economic Dynamics and Control, Elsevier, vol. 79(C), pages 126-153.
    5. Zhao, Kai, 2017. "Social insurance, private health insurance and individual welfare," Journal of Economic Dynamics and Control, Elsevier, vol. 78(C), pages 102-117.

    More about this item

    Keywords

    E20; H30; Health insurance; Annuities; Precautionary saving;

    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General

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