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Life Insurance Demand under Health Shock Risk

SAFE Working Paper No. 40

55 Pages Posted: 9 Feb 2014 Last revised: 11 Jan 2016

Christoph Hambel

Goethe University Frankfurt

Holger Kraft

Goethe University Frankfurt

Lorenz S. Schendel

Goethe University Frankfurt

Mogens Steffensen

University of Copenhagen

Date Written: June 3, 2015

Abstract

This paper studies the life cycle consumption-investment-insurance problem of a family. The wage earner faces the risk of a health shock that significantly increases his probability of dying. The family can buy long-term life insurance that can only be revised at significant costs, which makes insurance decisions sticky. Furthermore, a revision is only possible as long as the insured person is healthy. A second important feature of our model is that the labor income of the wage earner is unspanned. We document that the combination of unspanned labor income and the stickiness of insurance decisions reduces the long-term insurance demand significantly. This is because an income shock induces the need to reduce the insurance coverage, since premia become less affordable. Since such a reduction is costly and families anticipate these potential costs, they buy less protection at all ages. In particular, young families stay away from long-term life insurance markets altogether. Our results are robust to adding short-term life insurance, annuities and health insurance.

The appendices for this paper are available at the following URL: http://ssrn.com/abstract=2712267.

Keywords: Health shocks, Portfolio choice, Term life insurance, Mortality risk, Labor income risk

JEL Classification: D14, D91, G11, G22

Suggested Citation

Hambel, Christoph and Kraft, Holger and Schendel, Lorenz S. and Steffensen, Mogens, Life Insurance Demand under Health Shock Risk (June 3, 2015). SAFE Working Paper No. 40. Available at SSRN: https://ssrn.com/abstract=2392384 or http://dx.doi.org/10.2139/ssrn.2392384

Christoph Hambel

Goethe University Frankfurt ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

Holger Kraft (Contact Author)

Goethe University Frankfurt ( email )

Faculty of Economics and Business Administration
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Lorenz S. Schendel

Goethe University Frankfurt ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

Mogens Steffensen

University of Copenhagen ( email )

Universitetsparken 5
DK-2100 Copenhagen
Denmark

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