Does Cognitive Ability Impact Life Insurance Policy Lapsation?

Abstract

Life insurance is an important household risk management and financial tool. Policy lapsation has economic effects on life insurance companies, policyholders, and beneficiaries and the impact may be detrimental when these lapses are unexpected. Prior literature has examined several hypotheses of life insurance lapse focusing mainly on macroeconomic factors using aggregate data and household microeconomic factors using household-level data. We introduce and test individual cognitive ability variables in a model of the life insurance voluntary lapse decision by individual policyholders using household-level data from the Health and Retirement Study. We find that one measure of cognitive ability in particular, numeracy, is related to the voluntary lapse decision. While controlling for numeracy, we find evidence that those individuals with higher levels of net worth are less likely to voluntarily lapse a policy which is consistent with the emergency fund hypothesis. We introduce a new measure of liquidity shock, kids moving home, into the model and find it has a strong positive relationship with the decision to voluntarily lapse a policy. Consistent with life insurance demand theory, we find that those who have recently entered retirement are more likely to lapse their policy.

Keywords: Health and Retirement Study; life insurance; cognitive ability; lapsation

JEL Classification: G22, D14, D12