Closed for Business: Counterparty Risk and Insurance Purchase Decisions

Long-term insurance contracts, such as those for annuities or long-term care insurance, require confidence among purchasers that the contracts will be honored far into the future and may be seen as less valuable if consumers believe there is risk that these contracts will not be fulfilled.  In this paper, we investigate whether demand for long-term care insurance is related to perceptions of counterparty risk as it pertains to the risk that an insurance company will no longer be in business; the risk that an insurance company will not honor reasonable claims; and the risk that an insurance company will increase premiums in the future.  We investigate this relationship by fielding a unique survey in the American Life Panel asking for subjective assessments of counterparty risk and insurance coverage. 

We find that subjective assessments of counterparty risk are correlated with insurance ownership in that those with higher levels of perceived risk have lower rates of long-term care insurance.  These results are robust to a wide variety of alternative specifications of insurance coverage and do not appear to be the result of justification bias which may cause individuals who have coverage to report low levels of counterparty risk to justify their purchase.   We also investigate the relationship between subjective counterparty risk and other types of insurance contracts, and find similar results among contracts that are long-term in nature (such as annuities) but weaker results among insurance products with annual contracts like health insurance and disability insurance.