Mortality Risk, Insurance, and the Value of Life

Economic models of risks to life and health are widely employed to assess the costs and benefits of public policies. Yet, these models fail to explain a number of common phenomena, such as the large fraction of spending that occurs near the end of life and a positive correlation between fatality risk and the willingness to pay for life-extension. These and other anomalies have led some authors to abandon the standard framework and posit a variety of ad hoc alternatives. However, we show that the standard framework accounts naturally for these phenomena, as soon as one relaxes its restrictive and unrealistic assumption of complete annuity markets. This generalized life-cycle model predicts that a fixed survival gain is worth more to individuals facing bleaker survival prospects, and vice-versa. This insight yields a number of novel policy implications. First, the commonly observed practice of spending disproportionately more resources on individuals facing limited life expectancies may be efficient, not problematic. Second, conventional methods currently used by public and private health insurers undervalue life-extension for severely ill patients compared to the moderately ill, because the value of a statistical life-year varies with the level of mortality risk. Third, public annuity programs like Social Security are strong complements for investments in retiree healthcare, because they increase the value of remaining life for the elderly. For example, annuitization roughly doubles the value of statistical life for a typical 85-year-old American. Finally, holding life-extension benefits constant, treatments are more valuable than preventive technology, because they extend life for people that value it the most.