by Eric Young

The goal of this project is to develop a life cycle model of life insurance decisions. The salient features of the data are a positive relationship between measures of economic well-being (earnings, income, or wealth) and the face value of life insurance holdings, a strong life cycle component to holdings with a peak around age 50, and very low living standards for single widows. The overall question that the project is intended to answer is whether this pattern of life insurance purchases is indicative of market failure, and thus whether policy intervention is indicated, or does a standard model with actuarially-fair markets reproduce the key patterns?

The project develops a quantitative life cycle model in which households (defined as a married male and female) choose consumption, savings, labor supply, and life insurance to maximize lifetime utility. The household faces random wages in the labor market and a risk that one (or both) members dies. Households that die completely receive a warm-glow bequest utility. A competitive market for life insurance prices one-period contracts, and these contracts may or may not fairly price mortality risk (either due to asymmetric information or fixed costs). This model is estimated using data from the Survey of Consumer Finances, the Consumption Expenditure Survey, the Panel Study of Income Dynamics, and the Census to match some key facts about the income and wealth distribution, the amount of spending on life insurance, the process for individual wages, and the mortality rates of individuals. Given these parameters, the model is used to assess whether the life cycle pattern of life insurance holdings matches that found in the data. Several key components of the model are removed to assess their importance, including the unrestricted choice of hours worked, the presence of estate taxation, the degree to which consumption expenditures are public within the household and the length of the household’s effective planning horizon.

The next stage in the project is to study certain public policy programs that may act as substitutes for life insurance purchased through the market. For example, Social Security provides survivor benefits to families who lose a primary earner, replacing private life insurance purchases. This program will be introduced into the decision problem of the household and the extent to which it alters private decisions can be studied.