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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.

Suggested Citation

  • Igal Hendel & Alessandro Lizzeri, 2003. "The Role of Commitment in Dynamic Contracts: Evidence from Life Insurance," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 118(1), pages 299-328.
    • Handle: RePEc:oup:qjecon:v:118:y:2003:i:1:p:299-328.
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    File URL: http://hdl.handle.net/10.1162/00335530360535216
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    JEL classification:

    • L0 - Industrial Organization - - General
    • D4 - Microeconomics - - Market Structure, Pricing, and Design

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