The demand for life insurance in OECD countries

Journal of Risk and Insurance, Sept, 2007 by Donghui Li, Fariborz Moshirian, Pascal Nguyen, Timothy Wee

ABSTRACT

This article examines the determinants of life insurance consumption in OECD countries. Consistent with previous results, we find a significant positive income elasticity of life insurance demand. Demand also increases with the number of dependents and level of education, and decreases with life expectancy and social security expenditure. The country's level of financial development and its insurance market's degree of competition appear to stimulate life insurance sales, whereas high inflation and real interest rates tend to decrease consumption. Overall, life insurance demand is better explained when the product market and socioeconomic factors are jointly considered. In addition, the use of GMM estimates helps reconcile our findings with previous puzzling results based on inconsistent OLS estimates given heteroscedasticity problems in the data.

INTRODUCTION

Life insurance demand has experienced a rapid growth over the last few decades, significantly outpacing worldwide income growth. Widespread socioeconomic changes have underpinned this development; particularly, the dramatic extension of life expectancy and the higher enrolment rate in tertiary education. All of these factors contribute to increasing the cost of dependence and provide the rationale for life insurance coverage. In addition, the limits of social welfare as tax pressure reaches a breaking point are now widely expected to stimulate life insurance consumption in the coming years, as households anticipate public institutions' covering fewer of their future financial needs. Market structure developments have similarly contributed to the increasing popularity of life insurance. The increasing openness of domestic markets to foreign competition following international trade agreements, especially the Uruguay round, have resulted in more attractive and better priced products that are better suited to customer demand. Furthermore, the development of financial savings in a retirement perspective is seen to bolster life insurance demand in rapidly aging economies.

Despite the increasing number of studies regarding the determinants of life insurance consumption, several issues remain unclear. In particular, what are the effects of social security expenditures? Likewise, is a longer life expectancy associated with a higher or lower demand for life insurance? Earlier papers concerned with micro-level determinants (e.g., Burnett and Palmer, 1984; Fitzgerald, 1987) and focused on the U.S. insurance market (e.g., Mantis and Farmer, 1968; Chen, Wong, and Lee, 2001) could not properly address these questions. In fact, only cross-country comparisons allow studying socioeconomic variables that change slowly over time, such as life expectancy, to have a measurable influence, which goes undetected in time series analyses. In addition, some economic variables assumed to have a theoretical influence, such as social security expenditures, cannot be disaggregated at the household level. Beenstock, Dickinson, and Khajuria (1986), Browne and Kim (1993), Outreville (1996), and, more recently, Beck and Webb (2003) illustrate the benefit of analyzing life insurance demand on a cross-country basis. However, the first of these studies relies on a limited number of developed countries, whereas the remaining three mix widely different economies. In other words, the study by Beenstock, Dickinson, and Khajuria (1986) is the only study that focuses on demand for life insurance m the OECD countries covering the years 1970 through 1981 and studying only 10 OECD countries. At the same time, the studies by Browne and Kim (1993) and Outreville (1996) focus on developing countries. However, the study by Beck and Webb (2003) cover both developed and developing countries in their sample. Although they separate developing countries from the whole sample that consists of both developed and developing countries, in their study, they did not conduct any specific testing exclusively for the OECD countries, and subsequently there is no attempt in their model to specify those determinants that could be more appropriate to reflect the characteristics of demand for life insurance in the OECD countries.

In other words, although Beck and Webb's (2003) study is the most comprehensive study of life insurance demand, the key determinants to assess demand for life insurance have been mainly those of developing countries, and hence, the variables that they chose were predominantly a reflection of this reality.

Thus, this study is the first study after Beenstock, Dickinson, and Khajuria (1986) that specifically identifies those factors that are most relevant to demand for life insurance and extends the coverage from 10 to 25 OECD countries. Furthermore, this is the first study in this area to use GMM estimation as a way of unraveling some of the statistical inconsistencies that one could have observed in the past studies owing to their use of OLS estimate. (The exception is Beck and Webb, 2003, who used the instrumental variables.) Furthermore, this study is the first study to conduct an empirical study of demand for life insurance for the OECD countries for the 1990s.