A Dynamic Analysis of the Demand for Life Insurance

ABSTRACT Prior research suggests that neither the choice to own life insurance nor the amount purchased is consistently related to the presence of children in the household. While these perplexing findings are based on a static framework, we alternatively examine life insurance demand in a dynamic framework as a function of changes in household life cycle and financial condition. Our results indicate both a statistically and economically significant relation between life events, such as new parenthood, and the demand for life insurance. We also provide new evidence in support of the emergency fund hypothesis: households in which either spouse has become unemployed are more likely than other households to surrender their whole life insurance. INTRODUCTION Research has empirically examined life insurance demand for over 50 years. Based on prior findings, Hau (2000) notes conflicting evidence for various traditional determinants of life insurance demand (e.g., age, marital status, number of children, education, working wife, family income, and net worth). (1) Similarly, Zietz (2003) finds that published research shows conflicting results for certain variables that are expected to be determinants of the demand for life insurance (e.g., education, family size, spouse working outside home, and birth order). More recently, although Bernheim et al. (2003a, 2003b) find no correlation between life insurance ownership and financial vulnerability (their IMPACT factor), Lin and Grace (2007) use an alternative IMPACT measure and find a positive relationship between financial vulnerability and the amount of life insurance purchased. (2,3) Table I categorizes and summarizes empirical results for life insurance demand variables. For life cycle variables, differences exist for age and educational levels. For family life cycle variables, differences exist for marital status and number of children. For the financial variables, differences exist in the relationship of the family's financial vulnerability and the insurance coverage purchased to address that vulnerability. (4,5) A common thread among prior empirical analyses of life insurance demand is that researchers have employ a static (rather than dynamic) framework. Such an approach is reasonable, given that household survey data are largely cross-sectional and generally do not follow the same households over several time periods. While cross-sectional data are useful in explaining current levels of insurance holdings in terms of current household characteristics (e.g., marital status, employment status, and number of children), cross-sectional data do not allow for an analysis of the impact of life events (e.g., getting married, changing jobs, or having a child) on life insurance demand. (6) Limitations of data used in previous life insurance demand research are important because the life cycle literature suggests that life insurance purchases are likely to follow various life events such as getting married, having a child, purchasing a home, and getting a new job, for which cross-sectional data are not well suited. Similarly, termination of life insurance is likely to follow other life events such as getting divorced, having a spouse die, becoming unemployed, and retiring. While the previous literature has provided a strong theoretical foundation as well as empirical evidence on the determinants of life insurance demand based on cross-sectional data (within a static framework), the literature has not employed panel data (within a dynamic framework) to examine the various life events hypothesized to relate to life insurance demand. Thus, the use of cross-sectional data in prior studies coupled with the disparity in results that have been reported in previous literature suggest that a dynamic analysis based on panel data may provide the basis for a deeper understanding of the determinants of life insurance demand. The purpose of this study is to capture the effects of various life events that are hypothesized to relate to life insurance demand. …