IDEAS home Printed from https://ideas.repec.org/p/nbr/nberwo/24993.html
   My bibliography  Save this paper

Liquidity Constraints and the Value of Insurance

Author

Listed:
  • Keith Marzilli Ericson
  • Justin R. Sydnor

Abstract

Liquidity constraints create preferences over how insurance contracts move money across both time and states because insurance can have a consumption-smoothing benefit. We incorporate liquidity constraints into a model in which insurance contracts span multiple consumption periods. We show that the insurance demand of rational liquidity-constrained individuals will differ qualitatively and quantitatively from the standard model’s normative benchmarks: they will not fully insure at actuarially fair prices when premiums are paid upfront, they may purchase insurance even when premiums are so high that insurance is dominated in the standard model, and they may pay to insure against events that are certain to happen. We provide simulations showing that liquidity constrained individuals will systematically violate normative benchmarks in ways that have been previously documented and interpreted as mistakes. We also provide new survey evidence that liquidity-constrained individuals are more likely to express a preference for dominated insurance plans, even when the standard rationale for avoiding such plans is explained. We discuss how liquidity constraints can affect the optimal design of partial insurance and highlight the need to account for liquidity when evaluating insurance demand.

Suggested Citation

  • Keith Marzilli Ericson & Justin R. Sydnor, 2018. "Liquidity Constraints and the Value of Insurance," NBER Working Papers 24993, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:24993
    Note: EH PE
    as

    Download full text from publisher

    File URL: http://www.nber.org/papers/w24993.pdf
    Download Restriction: no
    ---><---

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Armantier, Olivier & Foncel, Jérôme & Treich, Nicolas, 2023. "Insurance and portfolio decisions: Two sides of the same coin?," Journal of Financial Economics, Elsevier, vol. 148(3), pages 201-219.
    2. Tal Gross & Timothy J. Layton & Daniel Prinz, 2022. "The Liquidity Sensitivity of Healthcare Consumption: Evidence from Social Security Payments," American Economic Review: Insights, American Economic Association, vol. 4(2), pages 175-190, June.
    3. Non, Mariëlle & van Kleef, Richard & van der Galiën, Onno & Douven, Rudy, 2019. "The effect of reinsuring a deductible on pharmaceutical spending: A Dutch case study on low-income people," Health Policy, Elsevier, vol. 123(10), pages 976-981.
    4. Drake, Coleman & Ryan, Conor & Dowd, Bryan, 2022. "Sources of inertia in the individual health insurance market," Journal of Public Economics, Elsevier, vol. 208(C).
    5. Johannes G. Jaspersen, 2022. "When full insurance may not be optimal: The case of restricted substitution," Health Economics, John Wiley & Sons, Ltd., vol. 31(6), pages 1249-1257, June.
    6. Hayen, Arthur P. & Klein, Tobias J. & Salm, Martin, 2021. "Does the framing of patient cost-sharing incentives matter? the effects of deductibles vs. no-claim refunds," Journal of Health Economics, Elsevier, vol. 80(C).
    7. Marc A. Ragin & Benjamin L. Collier & Johannes G. Jaspersen, 2021. "The effect of information disclosure on demand for high‐load insurance," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 88(1), pages 161-193, March.
    8. Remmerswaal, Minke & Boone, Jan & Bijlsma, Michiel & Douven, Rudy, 2019. "Cost-sharing design matters: A comparison of the rebate and deductible in healthcare," Journal of Public Economics, Elsevier, vol. 170(C), pages 83-97.
    9. Non, Mariëlle & van Kleef, Richard & van der Galiën, Onno & Douven, Rudy, 2019. "The effect of reinsuring a deductible on pharmaceutical spending: A Dutch case study on low-income people," Health Policy, Elsevier, vol. 123(10), pages 976-981.
    10. David de Meza & Diane Reyniers, 2023. "Insuring Replaceable Possessions," Economica, London School of Economics and Political Science, vol. 90(357), pages 271-284, January.
    11. Mark Shepard & Ethan Forsgren, 2023. "Do insurers respond to active purchasing? Evidence from the Massachusetts health insurance exchange," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 90(1), pages 9-31, March.
    12. Chenyuan Liu & Justin R. Sydnor, 2018. "Dominated Options in Health-Insurance Plans," NBER Working Papers 24392, National Bureau of Economic Research, Inc.
    13. Benjamin L. Collier & Daniel Schwartz & Howard C. Kunreuther & Erwann O. Michel‐Kerjan, 2022. "Insuring large stakes: A normative and descriptive analysis of households' flood insurance coverage," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 89(2), pages 273-310, June.
    14. Minke Remmerswaal & Jan Boone & Michiel Bijlsma & Rudy Douven, 2017. "Cost-Sharing Design Matters: A Comparison of the Rebate and Deductible in Healthcare," CPB Discussion Paper 367.rdf, CPB Netherlands Bureau for Economic Policy Analysis.

    More about this item

    JEL classification:

    • D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
    • D15 - Microeconomics - - Household Behavior - - - Intertemporal Household Choice; Life Cycle Models and Saving
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • I13 - Health, Education, and Welfare - - Health - - - Health Insurance, Public and Private

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:24993. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://edirc.repec.org/data/nberrus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.