Life Insurance Consumption as a Function of Wealth Change

This paper used a large nationally representative longitudinal dataset to explore the association between changing socioeconomic factors and household consumption of life insurance across time. This study specifically examined the association between changes in wealth and life insurance consumption controlling for household characteristics and psychosocial factors. Empirical results indicate that during the 2004-2008 period, an increase in net worth was positively associated with purchases of additional cash value life insurance at the household level. Women and Black households were also more likely to increase their life insurance consumption during this period. Saving intention was likewise found to be positively associated with an increase in household life insurance consumption. Results suggest that life insurance acts a complement to, rather than substitute for, wealth. Implications of the findings of this study for individual investors, scholars and practitioners have been included. Introduction Life insurance consumption, and the factors associated with the demand for life insurance, is among the most studied topics in the general business domain. As a result, much is known about the causal triggers of life insurance consumption and the macroeconomic mechanisms that alter the use of life insurance in different marketplaces. Li, Moshirian, Nguyen, and Wee (2007), for instance, noted that governmental expenditures on social insurance programs tend to be inversely related to life insurance demand. They reported that consumers living in markets where social welfare programs are broad and extensive in coverage tend to have reduced costs associated with unexpected death. As such, social welfare tends to act as a substitute for private market life insurance coverage. Single-period macro-viewpoint studies using social welfare data offer intriguing insights into insurance consumption patterns. Again, consider the work of Li et al. (2007). Their observation that social welfare expenditures, at the governmental level, are negatively related to life insurance demand are premised on a key assumption; namely, “social security expenditure is a proxy for national wealth” (p. 641). They went on to state that when viewed holistically, selfinsurance (i.e., direct purchase of life insurance) can be substituted with wealth. That is, as wealth increases, the demand for life insurance should fall. However, their insight was based entirely on international macroeconomic data comparisons where wealth was measured using social welfare expenditures as a proxy for country wealth. Two ancillary questions come to mind Life Insurance Consumption 2 in the context of the insurance-wealth connection. The first asks if household wealth also acts as a substitute for self-coverage. The second asks if life insurance, at the household level, acts as a complement, rather than a substitute, for wealth. Surprisingly, there have been few attempts to address these questions directly. Zietz (2003) reviewed 12 studies that explicitly examined the association between wealth (i.e., net worth) and the demand for life insurance. While the majority found a positive association between consumption of life insurance and wealth, the findings were not consistent. Some researchers noted a negative association, while others found non-significant relationships between demand for life insurance and wealth. Mossin (1968) wrote what has since become the seminal piece on the wealth effect and insurance consumption. He found that wealth was associated with risk aversion. Although not necessarily causally related, he noted that consumers who exhibit higher household wealth tend to accept higher levels of financial risk. The implication being that wealth and risk aversion may, indeed, be related to life insurance consumption, with the wealth-insurance association being negative when risk aversion is controlled. Fischer (1973) noted that household wealth appears to act as a form of self-insurance, thus reducing the demand for life insurance over time. To make matters even more confusing, others, including Eisenhauer and Halek (1999), have also noted a relationship between wealth and risk aversion, but concluded that wealthier households are more likely to own life insurance. Their findings suggest the possibility that insurance is more of a complementary, rather than a substitute, good. It also is possible that life insurance consumption decisions are not independent and that wealthy consumers may be just as likely to purchase life insurance as low wealth consumers (Mayers & Smith, 1983) and vice-aversa. The purpose of this paper is multifaceted. The first objective involved testing the wealthinsurance association using household, rather than macroeconomic, data. The second purpose was to evaluate the demand for life insurance as a function of changing socioeconomic factors over time rather than viewing the demand for life insurance on a cross-sectional basis. The third objective entailed the inclusion of saving intention and risk aversion as possible covariates, with wealth, as factors explaining the demand for life insurance. The research reported in this paper adds to the existing literature by showing that Li et al.’s (2007) assertion that the consumption of life insurance declines as wealth increases may only be true at a macroeconomic level. Rather Life Insurance Consumption 3 than being a substitute for wealth, life insurance may act more like a complementary good when household data is examined. Review of Literature As mentioned in the introduction to this paper, much is already known about the factors associated with the demand for life insurance. Rather than reviewing this literature extensively, the following discussion highlights some of the key findings from the existing body of knowledge. Readers who are interested in a more comprehensive and historical review of the demand features of life insurance are encouraged to read a summary piece written by Zietz (2003). In her manuscript, Zietz provides one of the most comprehensive overviews of the key variables that have been tested as possible determinants of the demand for life insurance products. The key takeaway from her work is that little consensus exists among researchers, over time, as to what factors cause the consumption of life insurance to change, or when a variable is found to be important in explaining demand, how stable the relationship remains over time. As an example, much of the early life insurance literature points to household size as being a key factor shaping life insurance consumption. The original thought was families with many dependents would find the loss of a breadwinner’s income to cause economic hardship, thus increasing life insurance consumption among larger households (e.g., Berekson, 1972; Burnett & Palmer, 1984). While generally true, it is possible to find a few studies that show household size to be negatively associated with insurance demand (e.g., Auerbach & Kotlikoff, 1989), whereas other papers have been published showing no association between household size and life insurance demand (e.g., Anderson & Nevin, 1975; Duker, 1969). What this reveals is the intense interest among researchers to understand and explain life insurance consumption patterns on the one hand, but also, on the other hand, the existing need to more accurately define the determinants of life insurance consumption. Wealth and Life Insurance Human capital theory provides a starting point in the wealth-insurance discussion. According to Chen, Ibbotson, Milevsky, and Zhu (2006), consumer wealth is comprised of two elements: financial assets and human capital. Human capital is generally defined as the present value of all future labor income. Theory suggests that consumers allocate resources presently to maximize both current and future consumption. In some respects, financial and human capital are substitute assets. That is, younger consumers tend to possess fewer financial resources (i.e., Life Insurance Consumption 4 they have a low net worth) because they have had fewer years to amass financial wealth. On the other hand, consumers at the beginning of their careers generally have higher human capital than others. Over time, the relationship between financial wealth and human capital wealth tends to shift. Theoretically then it is logical for those with a low financial wealth to human capital wealth ratio to own life insurance as a way to hedge a loss in human capital. Those who exhibit greater wealth ought to be, theoretically and holding bequest motives constant, less likely to demand life insurance. Although few studies have framed life insurance consumption issues in a human capital framework, there is some evidence to suggest that the wealth-insurance demand choice is negative (Lewis, 1989). Hau (2000), on the other hand, noted, using data from the Survey of Consumer Finances, that wealth was positively associated with insurance demand. However, some of the demand in his study might have been attributable to a need among very wealthy and older households to obtain estate liquidity to fund tax liabilities and charitable bequests. As a way to partially address this potentiality when identifying the demands for life insurance, this research attempts to minimize the effect of outliers in wealth and age-based bequest motives by delimiting the analysis to respondents age 43 and 51 in 2008 and adjusting net worth to reflect changes in wealth over time periods. In effect, this analytical approach alters the debate from hinting that absolute financial wealth determines life insurance demand to one suggesting that changes in wealth may also be an important trigger in changing life insurance consumption. This framework matches more closely with Li et al.’s (2007) notion that increases or decreases in wealth, rather than absolute levels of wealth, relate to life insurance demand. Income and Life Insurance