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Pay What Your Dad Paid: Commitment and Price Rigidity in the Market for Life Insurance

Author

Listed:
  • Radoslaw Paluszynski

    (University of Houston)

  • Pei Cheng

    (UNSW Business School)

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 and calibrate a model where policyholders are held-up by long-term insurance contracts, resulting in a time inconsistency problem for the firms. The optimal contract 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.

Suggested Citation

  • Radoslaw Paluszynski & Pei Cheng, 2019. "Pay What Your Dad Paid: Commitment and Price Rigidity in the Market for Life Insurance," Discussion Papers 2019-02, School of Economics, The University of New South Wales.
    • Handle: RePEc:swe:wpaper:2019-02
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    File URL: http://research.economics.unsw.edu.au/RePEc/papers/2019-02.pdf
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    References listed on IDEAS

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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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