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Commitment versus Flexibility and Sticky Prices: Evidence from Life Insurance

Author

Listed:
  • Radoslaw Paluszynski

    (University of Houston)

  • Pei Cheng Yu

    (UNSW Sydney)

Abstract

Life insurance premiums display significant rigidity in the data, on average adjusting once every 3 years by more than 10%. This contrasts with the underlying marginal cost which exhibits considerable volatility due to the movements in interest and mortality rates. We build a dynamic model where policyholders are held-up by long-term insurance contracts, resulting in a time inconsistency problem for the insurer. The optimal contract balances commitment and flexibility and takes the form of a simple cutoff rule: premiums are rigid for cost realizations smaller than the threshold, while adjustments must be large and are only possible when cost realizations exceed it. We use a calibrated version of the model to show that it matches the data and captures several aspects of premium rigidity in the cross-section and over time. (Copyright: Elsevier)

Suggested Citation

  • Radoslaw Paluszynski & Pei Cheng Yu, 2023. "Commitment versus Flexibility and Sticky Prices: Evidence from Life Insurance," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 49, pages 99-122, July.
    • Handle: RePEc:red:issued:20-112
    DOI: 10.1016/j.red.2022.07.003
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    More about this item

    Keywords

    Life insurance; Time inconsistency; Hold-up problem; Commitment; Flexibility;
    All these keywords.

    JEL classification:

    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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