Cognitive ability impact on life insurance lapsation

Abstract

Life insurance is an important household risk management and financial tool. Policy lapsation has economic effects on life insurance companies, policyholders, and beneficiaries that may be detrimental when these lapses are unexpected. Prior literature examined several hypotheses of life insurance lapse focusing mainly on macroeconomic factors using aggregate data and household microeconomic factors using household-level data. We introduce and test individual cognitive ability variables in a model of the life insurance voluntary lapse decision by individual policyholders using household-level data from the Health and Retirement Study. We find that one measure of cognitive ability, in particular, numeracy, is related to the voluntary lapse decision. While controlling for numeracy, we find evidence that those individuals with higher levels of net worth are less likely to voluntarily lapse a policy which is consistent with the emergency fund hypothesis. We introduce a new measure of liquidity shock, kids moving home, into the model and find it has a strong positive relationship with the decision to voluntarily lapse a policy. Consistent with life insurance demand theory, we find that those who have recently entered retirement are more likely to lapse their policy. © 2023 Academy of Financial Services. All rights reserved.