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Life Insurance and Life Settlements: The Case for Health‐Contingent Cash Surrender Values

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  • Hanming Fang
  • Edward Kung

Abstract

We investigate why life insurance policies in practice either do not have a cash surrender value (CSV), or have CSVs that are small and are not adjusted for health status. We show that including health‐contingent CSVs in a life insurance contract causes a dynamic commitment problem, which makes it more costly up front for policyholders to purchase long‐term contracts (because some poor risks who would otherwise have lapsed can and will now capture the CSV instead). To the extent that life insurance policyholders’ incomes tend to increase over the course of the policy, policyholders are not willing to accept higher ex ante premium costs in return for the extra liquidity provided by the CSV. Because health‐contingent CSVs act in a similar way to a life settlement market, we also study the life insurers’ equilibrium choice of CSVs in the presence of a life settlement market. We find that optimally chosen CSVs can partially mitigate the consumer welfare loss caused by the settlement market (as in Daily, Hendel, and Lizzeri, 2008), but only if the CSVs are allowed to be contingent on health status.

Suggested Citation

  • Hanming Fang & Edward Kung, 2020. "Life Insurance and Life Settlements: The Case for Health‐Contingent Cash Surrender Values," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 87(1), pages 7-39, March.
    • Handle: RePEc:bla:jrinsu:v:87:y:2020:i:1:p:7-39
    DOI: 10.1111/jori.12265
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    Cited by:

    1. Daniel Bauer & Jochen Russ & Nan Zhu, 2020. "Asymmetric information in secondary insurance markets: Evidence from the life settlements market," Quantitative Economics, Econometric Society, vol. 11(3), pages 1143-1175, July.
    2. Michael Hoy & Afrasiab Mirza & Asha Sadanand, 2021. "Guaranteed renewable life insurance under demand uncertainty," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 88(1), pages 131-159, March.
    3. Hanming Fang & Edward Kung, 2021. "Why do life insurance policyholders lapse? The roles of income, health, and bequest motive shocks," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 88(4), pages 937-970, December.
    4. Juan Pablo Atal & Hanming Fang & Martin Karlsson & Nicolas R. Ziebarth, 2020. "Long-Term Health Insurance: Theory Meets Evidence," PIER Working Paper Archive 20-009, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
    5. Fang, Hanming & Wu, Zenan, 2020. "Life insurance and life settlement markets with overconfident policyholders," Journal of Economic Theory, Elsevier, vol. 189(C).
    6. Siti Nurasyikin Shamsuddin & Noriszura Ismail & Nur Firyal Roslan, 2022. "What We Know about Research on Life Insurance Lapse: A Bibliometric Analysis," Risks, MDPI, vol. 10(5), pages 1-19, May.

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