Commitment Versus Flexibility and Sticky Prices: Evidence from Life Insurance

53 Pages Posted: 22 Mar 2019 Last revised: 16 Sep 2019

See all articles by Radoslaw Paluszynski

Radoslaw Paluszynski

University of Houston

Pei Cheng Yu

UNSW Australia Business School, School of Economics

Multiple version iconThere are 2 versions of this paper

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 model where policyholders are held-up by long-term insurance contracts, resulting in a time inconsistency problem for the fi rms. 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

Paluszynski, Radoslaw and Yu, Pei Cheng, Commitment Versus Flexibility and Sticky Prices: Evidence from Life Insurance (February 28, 2019). UNSW Economics Working Paper 2019-02, Available at SSRN: https://ssrn.com/abstract=3344346 or http://dx.doi.org/10.2139/ssrn.3344346

Radoslaw Paluszynski

University of Houston ( email )

4800 Calhoun Road
Houston, TX 77204
United States

Pei Cheng Yu (Contact Author)

UNSW Australia Business School, School of Economics ( email )

High Street
Sydney, NSW 2052
Australia

HOME PAGE: http://pcyu.weebly.com

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