Racial Differences in the Demand for Life Insurance

ABSTRACT The objective of this article is to measure racial differences in the proportion of human capital that households protect with life insurance. Using the 2004 Survey of Consumer Finances data, racial differences in two stages of the process are tested, where it is assumed that households must decide both whether or not to purchase life insurance and how much of their human capital to insure (if they decide to purchase). Among married and cohabitating households, we find that, controlling for demographics and other factors, there is little difference in life insurance ownership between black and white households but that white households insure a larger proportion of their human capital than black households. INTRODUCTION Life insurance is traditionally used to ensure that the economic well-being of the household is not adversely affected by the death of any of its members. Racial differences in life insurance, therefore, have direct implications for racial differences in economic well-being. The average white household has a net worth approximately three times greater than that of the average black household (Wolff, 1994; Kennickell, Starr-McCluer, and Surette, 2000). Racial differences in life insurance expenditure can either be mitigating or exacerbating this difference, depending on the direction of these differences. Furthermore, racial differences in life insurance expenditure can help us to better understand the underlying reasons for racial differences in savings and financial planning behavior in general. A household's insurance expenditures are presumably related to the risk aversion of its household members, the relative costs of insurance protection, and the information available to the household regarding both. All things being equal, one would expect the proportion of human capital that households insure to be equal across races; there are three main reasons why all things may not in fact be equal. First, the insurance literature has shown that there are observable characteristics that help explain life insurance demand, and if these characteristics are not possessed by both races equally, then we would expect racial differences. Second, there may be unobservable differences between the races with respect to insurance demand, due in particular to unobservable differences in risk aversion, which could lead to differences in the demand for insurance. There is evidence that black households are less tolerant of risk in the assets they choose to hold (Badu, Daniels, and Salandro, 1999), and that they prefer more liquid assets (Brimmer, 1991). If black households are indeed more risk averse than their white counterparts, this would imply that black households purchase relatively larger amounts of life insurance. Lastly, there could be racial differences in access to life insurance, or differences in actuarially fair prices, that would systematically lead one group to insure more than another. DETERMINANTS OF LIFE INSURANCE DEMAND Life-Cycle Economics and the Influence of Risk Aversion on Life Insurance One of the main paradigms used for framing the decision to buy life insurance is the life-cycle income hypothesis (Ando and Modigliani, 1963), which assumes that households use financial markets to smooth lifetime consumption and, therefore, expected lifetime utility. In the context of life insurance, this means purchasing enough life insurance for each person such that the financial impact of each person's death on the other household members would be 0. Fischer (1973) was the first to systematically apply the life-cycle model to life insurance purchases. Major theoretical results from this article include the relative importance of bequest motive and actuarial fairness of the life insurance market (as opposed to the bond return) in determining insurance demand. Additionally, the more labor income a person receives (relative to living off the proceeds of one's wealth), the more likely one is to purchase life insurance. …