Commitment Versus Flexibility and Sticky Prices: Evidence from Life Insurance
65 Pages Posted: 1 May 2018 Last revised: 1 Apr 2022
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Commitment Versus Flexibility and Sticky Prices: Evidence from Life Insurance
Commitment Versus Flexibility and Sticky Prices: Evidence from Life Insurance
Date Written: February 28, 2019
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 a dynamic model where policyholders are held-up by long-term insurance contracts, resulting in a time inconsistency problem for the firms. The optimal contract balances commitment and flexibility and 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. We use a calibrated version of the model to show that it matches the data and captures several aspects of premium rigidity in the cross-section and over time.
Keywords: Life Insurance, Time Inconsistency, Hold-Up Problem, Commitment, Flexibility
JEL Classification: G22, L11, L14
Suggested Citation: Suggested Citation