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 total life insurance  Life insurance are simply too expensive (Mossin, 1968)  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 62Death income

Lifetime consumption & savings Age $ 22 62Death income consumption

Lifetime consumption & savings Age $ 22 62Death income consumption borrow save “dis-save”

The Economic Model Can be reduced to a dynamic stochastic optimization problem

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 ：

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 ：

Model Analysis Demand estimation for term life insurance

Implication for China  Empirical estimation of the loading factors of insurance 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

Thanks and Your Feedback  Wenge Zhu  Tel: 