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The Puzzle of the Paucity of Demand for Life Insurance in China: an Economic Analysis
Wenge Zhu, Ph. D.Shanghai University of Finance and Economics
Presentation at 2005 IIS Seminar, Hong Kong
Contents
Introduction The Economic Model Model Analysis Implication for China Conclusion
Introduction Insurance in China: Several
Stylized Facts and a Puzzle The Possible Economic
Explanations and Their Shortcomings
The Effect of the Loading Factor: an Extensive Analysis
Insurance in China: Several Stylized Facts
The average annual growth rate of insurance premiums is more than 20% while that of GDP is about 10% in the past 10 years
Insurance penetration is about 3% and insurance density is about 400RMB (50U$)
Most growth of premiums come from life insurance business, with the proportion of life insurance premium income in the total insurance premium has increased from 17% in 1985 to 77.6% in 2003
Insurance in China: Several Stylized Facts
Most growth of life insurance premium income comes from non-traditional products, i.e., participating policies, unit-linked and universal policies
Most policyholders look at their policies just as a kind of investment tools instead of tools to protect against insurance risk
2004 has seen stagnation in the life insurance premium growth. The growth rate is about 7%. In Shanghai and Beijing, life insurance premium income was decreasing in 2004
The Puzzle of the Paucity of Demand for Life Insurance in
China
Arrow (1971): If insurance is sold at actuarially fair price, an individual will prefer full insurance
Almost all prediction say that China’s life insurance market has huge growth potential
So, Why there appears the paucity of demand for life insurance in China, especially for those traditional protective products?
Possible Economic Explanations and Their Shortcomings
Information asymmetry and Adverse Selection (Rothschild and Stigliz, 1976)
In life insurance one may effectively prevent it by proper underwriting examinations
Bequest motives (Modigliani, 1986) May help explain individual annuities shortfall But cannot be used to explain the paucity of demand for t
otal life insurance Life insurance are simply too expensive (Mossin, 19
68) Does not consider risks other than insurance risk Static model and mainly discuss non-life insurance
The Effect of the Loading Factor: an Extensive Analysis
Continuous-time dynamic model (Merton, 1969, 1971)
Consider insurance risk (Young and Zariphopoulou, 2002)
Lifetime consumption & savings
Age
$
22 62 Death
income
Lifetime consumption & savings
Age
$
22 62 Death
income
consumption
Lifetime consumption & savings
Age
$
22 62 Death
income
consumption
borrow
save“dis-save”
The Economic Model
Can be reduced to a dynamic stochastic optimization problem
PlmwW
mYYWUedsssCUeE
t
T
t TTTTs
WmC
)1(
)]()),((~
[max},,{
Demand for Term Life Insurance
Proposition 1 ： The Optimal Term Life Insurance Purchasing Strategy Assume the conditions in the above discussion are satisfied. The optimal term life insurance purchasing strategy is given by the following formula for the optimal proportion of insurance m ：
]
])1(1[
)1(ln[
11
txtT
txtT
txtT
txtT
q
p
ql
ql
Lm
Demand for Pure Endowment Insurance
Proposition 2. The Optimal Pure Endowment Insurance Purchasing Strategy Assume the conditions in the above discussion are satisfied. The optimal pure endowment insurance purchasing strategy is given by the following formula for the optimal proportion of insurance m：
]
])1(1[
)1(ln[
11
txtT
txtT
txtT
txtT
p
q
pl
pl
Am
Model Analysis
Demand estimation for term life insurance
0,0,0,0
L
m
l
m
q
mm
0%
20%
40%
60%
80%
100%
0.5 1 1.5 2 2.5 3 3.5 4 4.5 5
risk aversion
insu
ranc
e w
eigh
t
10% 20% 30%
0%
20%
40%
60%
80%
100%
120%
0% 5% 10% 15% 20% 25% 30%
loading factor
insu
ranc
e w
eigh
t
0. 5 1 2 5
Implication for China Empirical estimation of the loading factors of insur
ance products currently sold in China Data collected include products sold by: China Life,
Pingan Life, China Pacific Life, Taikang Life, AIA, Taiping Life and New China Life
Assuming the implied rate of return as 2.5%, the loading factors range from 10% to 30% with average of 14% for life insurance products
Those for annuities products are 8% to 15% with average of 12%
Other Possible Explanations
The irrational insurance behavior of Chinese people
Social security and Chinese tradition
Malfeasance behavior of agents and insurers
Inflation
Conclusion: Unanswered Issues
Non-level term structure of interest rate
Interest rate risk Demand for non-traditional
insurance products Imperfect market Correlation of insurance risk with
other market risks
