The role of commitment in dynamic contracts: Evidence from life insurance

Igal Hendel, Alessandro Lizzeri

Research output: Contribution to journalArticlepeer-review

125 Scopus citations

Abstract

We use data on life insurance contracts to study the properties of long-term contracts in a world where buyers cannot commit to a contract. The data are especially suited to test a theory of dynamic contracting since they include information on the entire profile of future premiums. All the patterns in the data fit the theoretical predictions of a model with symmetric learning and one-sided commitment aÌ la Harris and Holmstom. The lack of commitment by consumers shapes contracts in the way predicted by the theory: all contracts involve front-loading (prepayment) of premiums. Front-loading generates a partial lock-in of consumers; more front-loading is associated with lower lapsation. Moreover, contracts that are more front-loaded have a lower present value of premiums over the period of coverage. This is consistent with the idea that front-loading enhances consumer commitment and that more front-loaded contracts retain better risk pools.

Original languageEnglish (US)
Pages (from-to)299-327
Number of pages29
JournalQuarterly Journal of Economics
Volume118
Issue number1
DOIs
StatePublished - Feb 2003

Funding

* We are very grateful to Glenn Daily. We also thank Andrew Funderburk for research assistance, Jonathan Levin, Derek Neal, and Steven Tadelis for their comments, and LIMRA Int. and Compulife for generously providing us access to their data. Finally, we would like to thank Edward Glaeser and anonymous referees. The financial support of the National Science Foundation through grants SES 9986287 and SES 9911496 is gratefully acknowledged.

ASJC Scopus subject areas

  • Economics and Econometrics

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