Life Insurance and Pension Contracts I: The Time Additive Life Cycle Model
52 Pages Posted: 27 Mar 2014
Date Written: March 25, 2014
We analyze optimal consumption in the life cycle model by introducing life and pension insurance contracts. The model contains a credit market with biometric risk, and market risk via risky securities. This idealized framework enables us to clarify important aspects life insurance and pension contracts. We find optimal pension plans and life insurance contracts where the benefits are state dependent. We compare these solutions both to the ones of standard actuarial theory, and to policies offered in practice. Implications of this include what role the insurance industry may play to improve welfare. The relationship between substitution of consumption and risk aversion is highlighted in the presence of a consumption puzzle. One problem related portfolio choice is discussed - the horizon problem. Finally, we present some comments on longevity risk and cohort risk.
Keywords: The life cycle model, pension insurance, optimal life insurance, longevity risk, the horizon problem, consumption puzzle
JEL Classification: D91
Suggested Citation: Suggested Citation