Behavioral aspects of household portfolio choice: Effects of loss aversion on life insurance uptake and savings

Abstract

This paper provides empirical evidence that loss aversion decreases insurance demand and increases savings demand using individual-level data on the US elderly. Specifically, loss-averse individuals have a significantly lower ownership rate of term life insurance which is pure insurance, and they have a higher ownership rate of whole life insurance, which has a savings element. This paper also shows that loss-averse individuals own a smaller amount of stock (equity) than others and a greater amount of non-risky financial assets, such as deposits and bonds. This aligns with the prospect theory's prediction that boundedly rational consumers may view pure protection insurance (term life insurance) as a “risky investment” like stocks because the insured may just lose the premiums if a bad event does not occur during the policy term. They instead opt for “safer options” such as whole life insurance, which guarantees payment of a death benefit, or deposits and bonds. Furthermore, this paper provides suggestive evidence that loss aversion has a negative impact on insurance demand beyond the US, by showing that there is a negative association between loss aversion and insurance penetration rates in 51 countries.