Pay What Your Dad Paid: Commitment and Price Rigidity in the Market for Life Insurance

Abstract

Life insurance premiums display significant rigidity in the data, on average adjusting once every 3 years by more than 10%. This contrasts with the underlying marginal cost which exhibits considerable volatility due to the movements in interest and mortality rates. We build and calibrate a model where policyholders are held-up by long-term insurance contracts, resulting in a time inconsistency problem for the firms. The optimal contract takes the form of a simple cutoff rule: premiums are rigid for cost realizations smaller than the threshold, while adjustments must be large and are only possible when cost realizations exceed it.