Why Do Life Insurance Policyholders Lapse? The Roles of Income, Health and Bequest Motive Shocks

TitleWhy Do Life Insurance Policyholders Lapse? The Roles of Income, Health and Bequest Motive Shocks
Publication TypeReport
Year of Publication2010
AuthorsFang, H, Kung, E
InstitutionNew Haven, Yale University
KeywordsInsurance, Methodology

We present an empirical dynamic discrete choice model of life insurance decisions designed to bypass data limitations where researchers only observe whether an individual has made a new life insurance decision but but do not observe the actual policy choice or the choice set from which the policy is selected. The model also incorporates serially correlated unobservable state variables, for which we provide ample evidence that they are required to explain some key features in the data. We empirically implement the model using the limited life insurance holding information from the Health and Retirement Study (HRS) data. We deal with serially correlated unobserved state variables using posterior distributions of the unobservables simulated from Sequential Monte Carlo (SMC) methods. Counterfactual simulations using the estimates of our model suggest that a large fraction of life insurance lapsations are driven by i.i.d choice specific shocks, particularly when policyholders are relatively young. But as the remaining policyholders get older, the role of such i.i.d. shocks gets less important, and more of their lapsations are driven either by income, health or bequest motive shocks. Income and health shocks are relatively more important than bequest motive shocks in explaining lapsations when policyholders are young, but as they age, the bequest motive shocks play a more important role.

Endnote Keywords

Life insurance lapsations/Sequential Monte Carlo Method

Endnote ID


Citation Key5819