Life Insurance and Life Settlements: The Case for Health-Contingent Cash Surrender Values

40 Pages Posted: 19 Jul 2018

See all articles by Hanming Fang

Hanming Fang

ShanghaiTech University - School of Entrepreneurship and Management

Edward Kung

California State University, Northridge - David Nazarian College of Business and Economics

Date Written: July 19, 2018

Abstract

We investigate why life insurance policies in practice either do not have a cash surrender value (CSV), or have cash surrender values that are small and are not adjusted for health status. We show that including health-contingent CSVs to a life insurance contract causes a dynamic commitment problem, which makes it more costly up front for policyholders to purchase long term contracts (because some poor risks who would otherwise have lapsed can and will now capture the cash surrender value instead). To the extent that life insurance policyholders’ incomes tend to increase over the course of the policy, policyholders are not willing to accept higher ex ante premium costs in return for the extra liquidity provided by the cash surrender value. Because health-contingent CSVs act in a similar way to a life settlement market, we also study the life insurers’ equilibrium choice of cash surrender values in the presence of a life settlement market. We find that optimally chosen cash surrender values can partially mitigate the consumer welfare loss caused by the settlement market (as in Daily et al., 2008), but only if the cash surrender values are allowed to be contingent on health status.

Keywords: Life insurance, cash surrender values, life settlement market, reclassification risk insurance

JEL Classification: G22, L11

Suggested Citation

Fang, Hanming and Kung, Edward, Life Insurance and Life Settlements: The Case for Health-Contingent Cash Surrender Values (July 19, 2018). ShanghaiTech SEM Working Paper No. 2018-011, Available at SSRN: https://ssrn.com/abstract=3216405 or http://dx.doi.org/10.2139/ssrn.3216405

Hanming Fang (Contact Author)

ShanghaiTech University - School of Entrepreneurship and Management ( email )

100 Haike Rd
Pudong Xinqu, Shanghai
China

Edward Kung

California State University, Northridge - David Nazarian College of Business and Economics ( email )

Northridge, CA 91330
United States

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