The Role of Commitment in Dynamic Contracts: Evidence from Life Insurance

35 Pages Posted: 17 Mar 2000 Last revised: 10 Apr 2001

See all articles by Igal Hendel

Igal Hendel

Northwestern University - Department of Economics; National Bureau of Economic Research (NBER)

Alessandro Lizzeri

New York University - Department of Economics - Leonard N. Stern School of Business

Date Written: January 2000

Abstract

We look at the life insurance industry to study the properties of long term contracts in a world where consumers cannot commit to a contract. The main issue is how contracts are designed to deal with classification risk. We present a model that captures the main features of this industry. The data is especially suited for a test of the theory since it includes information on the entire profile of future premiums. The lack of commitment by consumers shapes contracts in the way predicted by the theory. All types of contracts involve front-loading. This generates a partial lock-in of consumers. Contracts that are more front-loaded have a lower present value of premiums over the period of coverage. This is consistent with the idea that more front-loaded contracts retain better risk pools. The estimates suggest that classification risk is almost completely insured by long term level-premium contracts.

Suggested Citation

Hendel, Igal E. and Lizzeri, Alessandro, The Role of Commitment in Dynamic Contracts: Evidence from Life Insurance (January 2000). NBER Working Paper No. w7470. Available at SSRN: https://ssrn.com/abstract=213431

Igal E. Hendel (Contact Author)

Northwestern University - Department of Economics ( email )

2003 Sheridan Road
Evanston, IL 60208
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Alessandro Lizzeri

New York University - Department of Economics - Leonard N. Stern School of Business ( email )

19 West Fourth Street
New York, NY 10012
United States
212-998-8907 (Phone)
212-995-3932 (Fax)

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