THE CURRENT LIFE INSURANCE CRISIS: HOW THE LAW SHOULD RESPOND
INTRODUCTION
Imagine a household consisting of a wife and husband with two small children. One of the spouses is the "primary earner" (in the sense of being the one who earns the most income); the other spouse is either the "secondary earner" or stays at home with the children. Assume further that the family, which is wholly dependent financially on the wages of the spouses or of the single primary earner, has enough income to cover the household's current expenses and to begin saving for the couple's retirement. They even make enough to set aside a little cash each year for the children's college fund, and are slowly saving to make a down payment on a house (or maybe they recently bought a house and are just beging to make payments on the mortgage). Things are going well. Life is good.
Then disaster strikes. The primary earner dies
unexpectedly, either from a sudden illness or an accident. What happens to the surviving members of the family? Aside from the obvious grief and psychological trauma associated with such an event, what happens to them financially? Does their standard of living plummet, or are they able to maintain some semblance of continuity from their previous life to their new one? The answer depends largely on whether the household (typically the primary earner himself or herself) at some point had decided to buy life insurance on his or her life. If there is too little life insurance coverage, the family may be forced to change their lives drastically, abandoning the college
·Professor of Law, University of I appreciate helpful comments from at the 1999 Harvard Law Seminar on Current Research in Tax
and the Michigan Law and Economics Workshop.
aspirations for their children and perhaps having to move to a smaller, less expensive home (or maybe giving up the hope of the newer, larger home for which they had been planning). Furthermore, the surviving spouse may be forced to take a second job or change careers or, if he or she had been a stay-at home spouse, to join the labor force and therefore alter drastically the family's plan for how the children would be raised. At the extreme, an inadequately insured household in such a situation would, despite the existence of social safety nets, be pushed into a state of profound and persistent poverty.1
This hypothetical suggests the importance of thinking carefully about one's (and one's dependents') life insurance needs. Such thinking does not provide easy answers; rather, it only suggests more questions: Under what circumstances should a household buy life insurance? Clearly, the hypothetical household described above needs some protection, but whom else? On whose life should the policy be purchased? How much coverage is appropriate? What type of policy is best? The problem is that these are questions that most of us try to ignore most of the time. True enough, there may be a brief period in our lives when we give the idea of buying life insurance some sustained thought, such as when we get married or when we have our first child. We may even return to the topic, at least cursorily, each time we receive a cold call from a life insurance agent. Still, it seems safe to say that the vast majority of us, most of the time, try to put life insurance questions out of our minds. By contrast, however, we seem to be growing increasingly obsessed with our investment portfolios, whether they be held inside or outside
our 401(k) or Roth IRA plans. And on-line stock trading has
become all the rage, even (and perhaps especially) for the most unsophisticated investors.
So why the reluctance to consider life insurance? The
1 See, Michael D. Hurd & David A. Wise, The Weal h and Poverty of Widows: Assets and the Husband's Death, in THE ECONOMICS OF AGING 177 (David Wise 1989) (discussing the high incidence of poverty
widows and exploring extent to which povert status arises as direct of death of husband); see also CHERYL D. RETZLOFF, LLIF, ACS, ET. AL 1998 SURVIVOR STUDY: THE FINANCIAL IMPACT OF DEATH 5-18 Gudith R. Kulak, 1998) (In cases in
which the priar earner dies asfte result of an extended illness, it fte resulting povert (or reduction in living standards) is a function not of inadequate life insurance coverage but also less than full health and disability insurance).
obvious answer is that thinking about life insurance is much less enjoyable than thinking about our investments. Life insurance planning, as with al estate planning, requires us to contemplate our own mortality; whereas, in contrast, thinking about lifetime savings-the money we stow away each month in savings accounts, mutual funds, or individual stocks-enables us to daydream about the exotic locations we will visit in our retirement or the fancy colleges our children will one day attend. Or maybe the problem is that most of us hate the process by which life insurance has traditionally been marketed, with face-to-face interrogations by earnest but sometimes overeager life insurance agents, followed by a special medical examination that might include blood and urine tests. The privacy concerns raised by such medical tests, especially when conducted by or for the benefit of insurance companies, increasingly have become a source of acute anxiety for many. In any event, the following assertion seems true: we generally regard the topic of life insurance, and the process by which is it purchased, to be unpleasant and best avoided when possible.
That attitude, if pervasive, presents a profound problem. It
raises the concern that those households that need life insurance most-for example, middle-income, wage-dependent households with small children-have too little coverage. More specifically, given the pervasively negative attitude towards the life insuring process, we should expect that a) too few households will buy life insurance on the lives of primary and secondary earners as well as on other members of the household, such as stay-at-home spouses, who provide substantial services; b) of those households ftat do buy life insurance, many will buy too little; and c) of those that buy enough coverage initially, many will fail to update their coverage to meet their changing needs. We would be right about these expectations. Recent empirical research on the subject suggests that there is widespread and substantial underconsumption of life insurance.2 According to the most
2 Astonishingly little independent (that is, not industry- unded) research has been done on the question of l e-insurance For the most
comprehensive ana empirical on the topic, see B. DOUGLAS
BERNHEIM, ET AL., THE OF LIFE INSURANCE: EVIDENCE FROM THE HEALTH
AND RETIREMENT SURVEY (Nat'! Bureau of Econ. Research, Paper No. 7372, 1999). Before that paper, the studies were a series by Alan J. Auerbach & Laurence J. see Al n J. Auerbach & L urence J.
Kotlikof , The Adequacy ofLife Insurance Purchases, 1 J. FIN. INTERME IATION 215
recent and most sophisticated study on the subject, fifty-five percent of households sampled were underinsured on the life of the primary earner, and twenty-one percent were underinsured on the life of the secondary eamer.3 These findings are consistent with findings of prior research, what little exists. 4 Yet none of these studies examines the adequacy of life insurance on the lives of nonwage-earning household
members, such as stay-at-home spouses. All of this evidence of insurance inadequacy comes despite the fact that, in 1998 for example, the per-household average amount of life insurance (for those households who had some type of life insurance policy) was $165,800.5 That may seem like a lot of money, but
it amounts to only 2.85 years worth of disposable income for
the average household-not much for a young family, recently deprived of its primary or secondary earner, on which to live. 6
Even if true, why is this a regulatory concern? Why should the law, or the government more generally, do anything in response to this problem? The reasons are straightforward. From the perspective of one concerned with maximizing overall "social welfare,"7 it can easily be shown that society is generally worse off when households fail to plan adequately for unexpected losses. As described in the hypothetical, underinsurance can produce involuntary reductions in standards of living, potentially below the poverty line in some cases. Note also that this concern with maximizing social welfare-and the worry that, with respect to life-insurance
(19 1) [Hereafter Auerbach & Kotlikoff, Adequacy of Insurance]; see ALAN J.
AUERBACH & LAURENCE]. KOTLIKOFF, LIFE INSURANCE
FROM A SAMPLE OF OLDER WI DOWS (Nat'l Bureau of Econ. Research, Working Paper No. 3765, 1991). [Hereafter Auerbach & Kotlikoff, Sample of Older Widows]; see Alan J. Averbach & Laurence J. Kotlikoff, Life Insurance of the Elderly: Its and Detenninants, WORK, HEALTH, AND INCOME AMONG THE ELDERLY 229 Burtless ed., 1987). As will be discussed more fully below, all of these studies find a substantial degree of underinsurance. These studies can
be contrasted with the hundreds of studies of savings behavior and adequacy that have been conducted.
3 Bernheim, et al., supra note 2, at 24.
4 See sources supra note 2.
5 AMERICAN COUNCIL OF LIFE INSURANCE, LIFE INSURANCE FACT BOOK at 12, TABLE
1.6 (1998). In 1997, Americans paid $115 billion in to life insurance AMERICAN COUNOL OF LIFE INSURANCE, INSURANCE FACT BOOK 64 the end of 1997, the total amount of life insurance in force was
roughly trillion. Id. at 2, table 1.1.
6 Id.
7 See generally Louis & Steven Shavell, Fairness Versus Human 114
HARV. L. REV. 961 that public policy should be made on the basis of effects on
decision making, that goal is not achieved-is almost identical with the concern that is presented by the problem of insufficient retirement savings; that is, when households put aside too little of current earnings to fund their desired post retirement standard of living. The problem of undersaving, however, has been widely acknowledged and exhaustively studied.
Post a Comment