does the secondary life insurance market threaten dynamic.pdfVIP

Does the Secondary Life Insurance Market Threaten Dynamic Insurance? Glenn Daily, Igal Hendel, and Alessandro Lizzeri∗ January 2008. 1 Introduction There is a vast theoretical literature on dynamic contracts that has received very little empir- ical attention (exceptions are Chiappori, Salanie and Valentin (1999) and Hendel and Lizzeri (2003)). This paper describes how a recent development in the life insurance market further illustrates the usefulness and power of the dynamic risk-sharing/learning model originally proposed by Harris and Holmstrom (1982). Life settlements are a recent innovation in the life insurance markets. Secondary mar- kets for life insurance policies started in large scale in the late 80s in response to the AIDS epidemic. Terminally ill policyholder exchanged their coverage for liquidity provided by a third party, a viatical firm. In the late 90s a market for non-terminal settlements emerged creating a secondary market for long-term policies: a policy holder with a life expectancy not exceeding 15 years can sell the policy to intermediaries who continue to pay the pre- miums in exchange for becoming the beneficiaries.1 Although estimates differ, the amount ∗Daily: Fee-only insurance consultant; , Hendel: Northwestern University, Lizzeri: New York University. We would like to thank Hanming Fang for helpful discussion 1 Typically settlements target relatively large policies, by holders over 65 years old with some health impairment but life expectancy as high 15 years. Viaticals targeted smaller policies but with life expectancy below two years. See Doherty and Singer 2002 for more on the origins and evolution of the market. 1 of settled insurance has been growing rapi