Saturday, March 26, 2016

Use Signaling to Overcome Information Asymmetry in Life Insurance

I hope you are a picture of health, but if you aren't let's pretend so for a moment.

You eat well, exercise, take care of yourself, and avoid undue risk in your lifestyle. Your family depends on your income and you want to insulate them for the financial burden caused by a freak accident that might happen to you. How do you communicate your great health to a life insurance carrier? Information asymmetry is an issue for the carrier who wants to cover you but cannot be sure that you are not withholding some valuable piece of information.

You need a way to signal your belief. Signaling that is costly to the signaler is the most valuable way to communicate your belief. Perhaps one way is to buy a policy that does not go inforce for X years (maybe X is 3). The carrier should interpret this favorably and lower your premiums considerably. Since you still need coverage in the short-term, you decide to buy a regularly-priced policy for that interim
period. But after X years, you are paying a low amount and your carrier is content with the arrangement. Any other creative signaling ideas?

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