A Multinomial logit based evaluation of the behavior of the life insureds in Romania

American Journal of Applied Sciences, Jan, 2009 by Cristian Dragos, Dragos Simona

INTRODUCTION

The study of the life insured's behavior has attracted the interest of a number of researchers in the past. Theoretical models on life insurance demand have been developed and empirical studies also have been conducted extensively to examine the influence of specific factors on the demand for life insurance.

This research proceeds to review the literature related to life insurance demand, to present the Romanian life insurance market, to describe the data and estimation model, to present and discuss the empirical results and to conclude with the findings of this study.

Economic theory predicts that households will save and insure in order to enjoy the same living standard over time and in the event of the death of a household head or spouse. Economic theory in this case accords with common sense and every day observation. "We save to be able to maintain our life styles in retirement. And we buy life insurance to make sure our survivors can continue to live at the same standard to which they have become accustomed" (1).

There is no unique theory for life insurance demand. Yaary (2) was the first to develop a theoretical framework to study the uncertainty of lifetime and the demand for life insurance. He predicted that investors make asset allocations decisions and life insurance purchase to maximize their lifetime utilities of wealth and consumption. Almost all of the theoretical works which study the impact of wealth and bequest motives on life insurance demand developed later have expanded their models based on the study of Yaary (2).

There are a number of empirical studies of life insurance demand that have been developed in the past. Bernheim (3) uses estimates of the demand for life insurance to assess the strength of bequest motives. He finds that a significant fraction of total saving is motivated by the desire to leave bequests. Browne and Kim (4) present evidence on life insurance demand across 45 countries. They find that the main determinants of country variations in the demand for life insurance are the dependency ratio (the number of dependents per potential life insurance consumer), income, inflation and price of insurance.

The findings of Browne and Kim (4) and Outreville (5) confirm that the income level affects significantly the life insurance demand. Life insurance becomes more affordable when income increases. Hwang and Greenford (6) examine some of the key factors affecting life insurance consumption in China, Hong Kong and Taiwan. Income and life insurance consumption are found to be strongly correlated, which is consistent with previous studies. In a comparative study, Truett and Truett (7) examine the variables affecting life insurance demand in Mexico and in U.S. The results have shown that age, education and income impact the demand for life insurance.

Over time, the life insurance decisions and the asset allocation have been analyzed separately, both in theory and practice. However, results from Headen and Lee (8) indicate that the demand for insurance is a function of variables such as savings, consumer sentiment and conditions if the financial market. Mayers and Smith (9) do not agree that wealthier consumers demand less insurance and find that the benefits of an insurance policy are identified with the returns of other financial assets. These results imply that decisions to purchase insurance are not independent of decisions to make other investments.

The human capital is the factor that makes the linking between insurance and investments decisions, because it affects both the optimal asset allocation and the demand for life insurance-Ibbotson & all (10). They defined the human capital as the present value of an investor's future labor income.

An investor's human capital contains a unique mortality risk, which is the loss of all future income and wages in the unfortunate event of premature death. Life insurance has been used for long time to hedge against mortality risk. The greater the value of human capital is, the more life insurance the family demands.

Younger investors have far more human capital than financial capital. This is because younger investors have more years to work and they have had few years to save and accumulate financial wealth. On the other hand, young investors tend to have more financial capital than human capital, since they have fewer years ahead to work but have accumulated financial capital over a long career.

The allocation of capital in risky asset decreases as the investor ages. This result (11) is due to the dynamic between human capital and financial wealth over time. When an investor is young, the investor's total wealth is dominated by the human capital. Since human capital in this case is less risky than the financial risky asset, young investors will invest more financial wealth into risky assets to offset the impact of human capital on the overall asset allocation. As the investor gets older, the allocation to risky assets is reduced, as human capital gets smaller.