Insuring Labor Income Shocks: The Role of the Dynasty

We study the importance of insurance provided by cash-rich parents to cash-constrained children experiencing earnings shocks. Using matched population data for Norway spanning two generations, we establish several results. First, parents respond to negative labor income shocks faced by their adult children by changing their saving choices. Consistent with dynastic insurance, we observe a negligible response when children's income shocks are positive. Second, parents’ responses depend on the nature of the shock. Temporary income losses lead parents to dissave, consistent with immediate transfers; persistent losses induce parents to increase savings in anticipation of future transfers. We find that parental insurance is substantial: on average, parents dissave 35 cents of liquid wealth in response to a $1 temporary loss, and set aside an additional 19 cents to fund future transfers in response to a $1 persistent loss. Third, insurance provision is weaker when children have access to alternative smoothing mechanisms, such as spousal labor supply, and it is stronger if children live geographically far from their parents. Finally, we do not find evidence of reverse insurance (children insuring their parents' labor income losses). Our results have implications for models studying the aggregate consequences of idiosyncratic labor income shocks.