LAUSR

We analyze the effects of life insurance settlement on insurance contract design, the insurer’s profit and welfare. Policyholders face not only mortality risks but also heterogeneous liquidity risks which lead the policyholders to surrender or settle the policies. It is assumed that the insurer cannot discriminate policyholders based on liquidity risks, and that no cost is incurred in surrender and settlement. We characterize the conditions for the endogenous existence of a settlement market, and find that the settlement market, if it exists, raises insurance premium. The effects of settlement on profit and welfare depend on the market structure. In the monopolistic insurance market, the settlement market lowers the insurer’s profit, and consumer welfare increases whenever demand increases and possibly increases even when demand decreases. This finding is in contrast with most of the existing studies reporting that settlement never has a positive effect on welfare. In the competitive insurance market, welfare always decreases.