Behavioral Aspects of Household Portfolio Choice: Effects of Loss Aversion on Life Insurance Uptake and Savings
47 Pages Posted: 29 Mar 2022
This paper hypothesizes that loss aversion may decrease insurance demand and increase savings demand based on the prospect theory. Using individual-level data from the Health and Retirement Study, this paper presents empirical evidence consistent with the hypothesis. Loss averse individuals have a significantly lower ownership rate of term life insurance which is pure insurance, and they have a higher ownership rate of whole life insurance, which has a savings element. This paper also shows that loss-averse individuals own a smaller amount of stock (equity) than others and a greater amount of non-risky financial assets, such as deposits and bonds. These results are consistent with the prospect theory, which predicts that boundedly rational consumers may view pure protection insurance, such as term life insurance, as a “risky investment” like stocks because the insured may just lose the premiums if a bad event does not occur within the pre-specified term. Hence, those who are fairly sensitive to potential loss choose not to buy term life insurance. They instead opt for “safer options” to prepare for uncertain future events either by purchasing whole life insurance, which guarantees payment of a death benefit, or by accumulating non-risky financial assets, such as deposits and bonds. These results indicate a significant role for behavioral biases in insurance and savings decisions.
Keywords: Loss aversion, Behavioral insurance, Term life insurance, Whole life insurance, Risky asset, Savings puzzle
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