Abstract

     Numerous countries cut payroll taxes in response to COVID-19, including China, which reduced employer contributions by up to 21 percentage points. We use administrative data on more than 800,000 Chinese firms to evaluate payroll tax cuts as a business relief measure. We estimate that the tax cuts cover 31.5% of the decline in business cash flow, but labor informality causes 53% of registered firms-24% of aggregate economic activity-to receive no benefits at all. We quantify the targeting of the policy in terms of how much benefits flow to small firms less able to access external finance and to sectors worse hit by COVID-19. We find that (1) small firms and vulnerable industries are comparatively more labor intensive, which leads to desirable targeting; (2) labor informality worsens, but does not eliminate, targeting by firm size; and (3) labor informality is uncorrelated with the COVID-19 shock, and therefore does not affect targeting by sector.

Policy background

     In the mid- to late-1990s, China adopted a mandatory “pay-as-you-go” pension system, Basic Old Age Insurance (BOAI), for employed persons funded mainly through employer contributions (see Fang and Feng (2018) for a history of pension programs in China). Likewise, in the early 2000s, a medical insurance (MI) program for employed persons was established, also funded by payroll taxes (Huang, 2020). These two programs are the largest components of the SI system. As of 2019, the nationally prescribed employer contribution rate for BOAI and MI was 16 and 8% of wages, respectively. BOAI and MI also require employee-side contributions-8 and 2%-which are recorded in notional individual accounts that are efectively pay-as-you-go.

Discussion and conclusion

     Many advanced economies responded to the COVID economic shock with fscal policies unprecedented in both scale and form. In comparison, China’s response to COVID by way of additional spending and foregone revenue is moderate as a proportion of its GDP and more typical for developing countries.28 Its payroll tax cuts amounted to about 1.68% of 2020 GDP, whereas in the USA the Paycheck Protection Program alone delivered government support equal to 4.55% of 2020 GDP.29 China’s choice of policy instrument was also conservative: instead of launching novel spending programs, it temporarily reduced rates under an existing tax.

Abstract

Existing literature has documented an increasing focus on financial resilience to better address the issue of multidimensional poverty in developing regions. The move to financial resilience is a part of a long process that has examined the relationship between poverty and financial access. Yet because financial resilience is a relatively new topic, the specifics of how financial resilience can be fostered using specific financial products has yet to be substantiated. Thus, this study offers an examination of the relationship between life insurance access and financial resilience in a sample of 16 middle-income Latin American countries, the first study of its kind. The objective of the research is to analyze the contribution of life insurance on supporting the development of financial resilience to strengthen the emergent middle-class to continue sustainable and inclusive growth in middle-income Latin America. This study reveals that life insurance access contributes positively and significantly to increasing financial resilience in middle-income Latin America with potentially significant effects on middle class resilience and sustained poverty alleviation.

1- Introduction

2- Background and hypotheses

3- Sample, variables and methodology

4- Results and discussion

5- Conclusion

References

Abstract

The gravity of insurance within the financial sector is constantly increasing. Reasonably, after the events of the recent financial turmoil, the domain of research that examines the factors driving the risk-taking of this industry has been signified. The purpose of the present study is to investigate the interplay between national culture and risk of insurance firms. We quantify the cultural overtones, measuring national culture considering the dimensions outlined by the Hofstede model and risk-taking using the ‘Z-score’. In a sample consisting of 801 life and non-life insurance firms operating across 42 countries over the period 2007–2016, we find a strong and significant relationship among insurance firms’ risk-taking and cultural characteristics, such as individualism, uncertainty avoidance and power distance. Results remain robust to a variety of firm and country-specific controls, alternative measures of risk, sample specifications and tests designed to alleviate endogeneity.

Introduction

“Differences in the way distinct countries subjectively value insurance products have not come into being by chance. Patterns of appreciation are part of the culture of a society.” Geert Hofstede (1995, p.423) Insurance is fast becoming an imperative element of the financial sector that significantly contributes to economic growth (Haiss & Sümegi, 2008). Understandably, this also makes it a significant vulnerability of the financial system that could potentially derail it, eventually leading to a negative impact on the whole economy (Das, Davies, & Podpiera, 2003; Harrington, 2009). Admittedly, this justifies policy-makers’ motives to reform the regulatory framework of this industry (Gaganis, Liu, & Pasiouras, 2015), further promoting confidence in its soundness (Cummins, Rubio-Misas, & Vencappa, 2017). Investigating the risk-taking of this domain is of paramount importance, especially as to what the unravelled global financial crisis revealed (Tarashev, Borio, & Tsatsaronis, 2009). Consequently, a number of studies delve into the factors driving the risk of insurers, shedding ample light in many respects. The plethora of existing studies focuses on firm-specific determinants (see Chen & Wong, 2004, pp. 470–473, for a detailed review). Turning to the macro-level strand of literature that our study is addressed at, we find a limited number of prior studies. These consider country-specific characteristics, such as the quality of institutions (Fields, Gupta, & Prakash, 2012), regulations (Pasiouras & Gaganis, 2013) and competition (Cummins et al., 2017) as drivers of the industry’s risk-taking. Arguably, these studies are greatly informative, yet far from being exhaustive. In particular, we find informal institutions, such as national culture – that has made its way through the literature over the past three decades (Kirkman, Lowe, & Gibson, 2006) – to be missing from the above explanatory list. Interestingly, anecdotal evidence and prior studies in the literature identify culture as a main determinant of financial institutions’ stability. More specifically, a thought-provoking survey conducted by PricewaterhouseCoopers and The Economist’s Intelligence Unit among financial services professionals in May 2008 reveals that 73% of the respondents identified “culture and excessive-risk taking” as the main drivers of the global financial crisis (PricewaterhouseCoopers, 2008).

1- Introduction

2- Literature review

3- Data, econometric results and interpretation

4- Conclusion

References

Abstract

This paper studies the stochastic relationship among six Latin American countries’ international bond issue risk premium. The analysis exploits a novel Corporate Emerging Markets Bond Indices (CEMBIs) database processed with a VAR-CCC model to clarify the nature of such relationships, and makes an objective interpretation of their characteristics. The countries included in the sample are Argentina, Brazil, Chile, Colombia, Mexico and Peru, and the daily observations period from May 14, 2014, through February 9, 2017. Our findings indicate that the CEMBI returns of Brazil and Mexico are the main influencers on the behavior of the other Latin American CEMBI returns. These insights are valuable to understand the diversification possibilities of CEMBI portfolios, and of interest to Latin American corporate financial managers who consider financing their firms with international bond issues, and for whom the risk premium paid by bond issues is the cost of funding.

Introduction

The quality spread of corporate bonds is defined as the excess return paid over the risk-free rate and is a sound indicator of the riskiness of the bond as an investment, but also has an obvious association with the cost of funding for the issuer. Higher spreads are equivalent to greater cost funds and, in that sense, have a significant influence over investment decisions of private firms which, in turn, have an impact on the creation of new jobs, and on other microeconomic and macroeconomic aspects. The investor and portfolio manager’s interest lies in the risk, return and potential diversification benefits achieved by different combinations of corporate bond portfolios. Within that context, exploring the trends and characteristics of corporate bond spreads is an issue of great economic and financial importance. During recent decades, emerging countries’ financial markets have registered significant growth and increasing sophistication at a global level, with the corporate bond segment leading, in most cases, that expansion. To have a sense of the magnitude of this growth, after the Global Financial Crisis (2008–2009) the annual issues of non-financial corporate bonds increased by a factor of more than three times during the five-year period from 2009 to 2014, a growth that easily outpaced both equity and syndicated loans (Ayala, Nedeljkovic, & Saborowski, 2015). To a large extent, the global economic recovery was supported by an extraordinarily relaxed monetary policy in the more developed countries that included not only historically low interest rates, but also an active participation of central banks in the purchase of troubled bonds, which is understandable when the most important aim is to create the conditions for aggregate demand and investment growth (Núñez Reyes, Perrotini Hernández, & López-Herrera, 2018).

This study extends previous research on the influence of CEO pay inequity on CEOs’ decision-making by examining the relationship in the acquisition context. Focusing on CEOs’ compensation vis-à-vis external and internal referents, we find that underpaid CEOs pay higher acquisition premiums and that overpaid CEOs pay lower premiums, although this tendency is reduced as the level of overpayment increases, creating a U-shaped relationship. We further find that the CEO-TMT pay gap moderates the relationship between CEO under-/ overpayment and acquisition premiums by adjusting CEOs’ perceptions of pay inequity and motivation to restore inequity through their higher or lower sense of self-importance. The findings of this study suggest that CEOs’ decision-making is strongly influenced by their framing of gains and losses and the perception of pay inequity vis-à-vis external and internal referents.

Introduction

Chief executive officer (CEO) compensation has received considerable attention over the last four decades. This body of literature has been influenced greatly by agency theory, and scholars often have examined how specific compensation packages affect behaviors and organizational outcomes (Devers, McNamara, Wiseman, & Arrfelt, 2008; Sanders, 2001). More recently, behavioral agency theory has been used to expand and modify many of the assumptions in agency theory (Wiseman & Gomez-Mejia, 1998). These modifications reveal important new insights into CEO compensation which have been summarized by Pepper and Gore (2015). Foremost among these new insights (for our paper) is an understanding from equity theory that agents maintain perceptions concerning equitable compensation. Agents implicitly make judgments concerning their compensation vis-à-vis market norms and personal referents (Pepper & Gore, 2015). The second insight is an understanding regarding agents’ risk preference drawing upon prospect theory.

Introduction

Aims and objectives

Literature review

Research methodology

Data analysis

Discussion of major findings

Conclusion

References

Abstract

This study examines the impact of liberalisation on the Indian insurance industry by examining it in terms of its efficiency characterised by functional performance. Data of 552 respondents from Indian life insurers was used for the empirical examination. Multivariate analysis of variance (MANOVA) was conducted to test the hypotheses that the linear combinations of impact of liberalisation on the Indian life insurance industry characterised by marketing mix, service quality and insurance awareness might differentiate between groups characterised by gender, place of residence, types of relationship with Life Insurance Corporation (LIC), types of employee positions in LIC, and types of relationship with private players. The results reveal a positive impact of liberalisation on the Indian life insurance industry.

Introduction

The Indian life insurance industry has transitioned from an open competitive sector to a protected regime and then back to being a liberalised insurance sector in its 360-degree journey over a period of more than a hundred years. Nationalisation of the life insurance sector took place on 1st September 1956, with issuance of ordinance by Government of India (GoI) to dissolve 245 units (154 Indian insurers, 16 nonIndian insurers and 75 provident societies) into a giant, government-owned, autonomous entity, namely, Life Insurance Corporation of India (LIC) (IRDA, 2007). The purpose of the nationalisation of the life insurance sector was to increase the penetration of life insurance in the country, particularly in the deep rural areas in order to provide adequate life insurance cover at a reasonable cost to all insurable individuals. However, with the passage of time, it has been observed that the protected regime in the insurance sector has resulted in low insurance penetration and density. A mass of insurable individuals has remained without insurance cover. In the year 1993, the GoI set up the Malhotra Committee to evaluate the Indian insurance sector in terms of examining its structure, assessing its strengths and weaknesses, and reviewing the existing regulatory provisions in order to suggest reforms. Recommendations of the Malhotra Committee laid the foundation for the entry of private players (Rao, 2008). With the passage of the Insurance Regulatory Development Authority (IRDA) bill in March 2000, the protected Indian insurance sector was opened up and the entry barriers were removed for private players. The IRDA allowed entry of global insurance players, only with their domestic partners and with a limit of 26% FDI cap. Thus, the era of competition began, and it has wrought a transition in the Indian insurance industry.

1- Introduction

2- CAT bonds and Asia Pacific markets

3- Liquidity hypotheses

4- Data

5- Empirical analysis and discussion

6- Conclusion

References

Abstract

This study measures liquidity in the catastrophe (CAT) bond market and the liquidity premium embedded in CAT bond spreads. The empirical results show that time to maturity, yield volatility, and yield dispersion from the primary market are the three most effective liquidity proxies. Given these three proxies, the average estimated liquidity premium in the CAT bond market is 67.57bps, accounting for only 9.42% of the average CAT bond spread (717.37bps) in the secondary market during the period 2002-2016. The average CAT bond liquidity premium is higher than the corporate bond liquidity premium of a similar risk class by about 35bps during the pre-crisis period. The more significant part of the high-yield spreads, 90.58%, is attributed to other risk natures of CAT bonds. Lastly, the liquidity premium increases dramatically after occurrences of severe natural catastrophes as well as during the 2008 financial crisis.

Introduction

Catastrophe (CAT) bonds, which are a type of insurance-linked securities (ILS), can resolve inefficiency in the reinsurance market and have been by far one of the most successful securitization structures to date (Cummins and Trainar, 2009).1 CAT bonds are a high-yield financial instrument, presenting an average spread of 717.37 basis points (bps) over LIBOR (London Interbank Offered Rate) and an excess spread of 322.74bps compared to similarly rated corporate bonds during the period 2002: Q2 to 2016: Q1. One theory is that their high-yield spreads are due to their liquidity premium, because CAT bonds are not publicly traded and their transactions are in the over-the-counter market (OTC). Various studies indicate that liquidity is factored into corporate bond yield spreads (Houweling et al., 2005; Chen et al., 2007; Bao et al., 2011; Dick-Nielsen et al., 2012; Schestag et al., 2016; Lo et al., 2019; etc.), but there is no evidence on how liquidity is related to CAT bond spreads. While we do not find any literature investigating the liquidity effect on CAT bond spreads, some relevant studies (Braun, 2016; Gürtler et al., 2016) do consider issue volume, maturity, and time to maturity in order to measure CAT bond liquidity in the primary market or secondary market for such bonds.2 To our surprise, these studies find no empirical evidence to support the liquidity hypothesis, implying that investors do not demand a liquidity premium for CAT bonds. Based on the above background, this study looks to examine whether the liquidity premium is present and, if so, to measure how much it is embedded in CAT bond spreads. Previous studies of CAT bonds focus on finding price determinants of their yield spreads.

This article investigates the dynamic linkage between insurance and banking activities from the asset size of the insurance sector in the context of a panel vector autoregression (VAR) framework utilizing data for 73 countries from 1980 to 2014. Panel Granger-causality tests show that a Granger-causal relation generally runs from banking activities to insurance sector assets. Impulse response analyses for the whole sample demonstrate that the size of insurance assets responds positively to a shock to liquid liabilities and deposits of the financial system, but negatively to a shock to deposit money bank assets as well as private credit issued by commercial banks, other financial institutions, and deposit banks. The observations are qualitatively identical for high-income countries, while the results are largely different for middle- and low-income countries. Moreover, we observe a significant interaction between insurance and banking activities in civil-law countries rather than in common-law ones.

Introduction

The banking and insurance sectors, two major branches of the financial industry, exert a substantial influence on an economy’s operations. The banking sector contributes to the economy mainly by financial intermediation that channels funds efficiently between savings and investments and thus promotes capital formation. The insurance sector, on the other hand, matters mainly in terms of risk transfer and loss indemnity that could mitigate threats of risk, which could sustain an entity’s resistance to risk and thus encourage production activities. Moreover, the insurance sector also exerts a financial intermediary function, because the considerable premiums it collects constitute an important funding source for capital markets. Academic studies do find evidence that generally supports the relevance of the two sectors by documenting a positive connection between economic growth and banking (Beck et al., 2000; Levine et al., 2000) and insurance activities (Arena, 2008; Han et al., 2010). Although the banking and insurance sectors exert different functions for an economy, some interrelations are present between them. The two sectors cooperate as well as compete in many respects. For instance, risk transfer and loss indemnity provided by the insurance sector, mainly in the non-life insurance sector, alleviate the impact of adverse shocks on production activities and could thus protect banks’ loans indirectly, which can encourage more loans and further promote financial intermediary activities of banking. Moreover, banks are an important channel for the sale of insurance products, the so-called bancassurance, in some countries, and the practice has gradually been adopted in other parts of the world. On the other hand, as financial institutions, the banking and insurance sectors, mainly the life insurance sector, both absorb funds from society and make loans or investments, and therefore some competition for funds between them may be present. The literature does implicitly or indirectly document a complementary (Webb et al., 2002; Beck and Webb, 2003; Bernoth and Pick, 2011; Lee and Chang, 2015) as well as substitutive (Haiss and Sümegi, 2008; Tennant and Abdulkadri, 2010) relation between the two sectors when exploring the relevance of banking or insurance activities to the economy. Song and Thakor (2010) show that insurance activities and bank credit may be complementary or substitutive under different circumstances. The divergent evidence suggests that the linkage between insurance and banking activities may be so intricate that an investigation from different perspectives is warranted in order to have a deeper realization.

As the death or a major accident of a key person will bring a firm with disastrous losses, key person insurance has attracted increasing attention worldwide. But key person insurance is a double-edged sword because it has both positive and negative effects on a firm’s performance. Different from prior papers, this study proposes to capture the two opposite effects of key person insurance by using a microeconomic analysis. The novel contribution of this paper is that besides risk-reducing effects of key person insurance, we find that key person insurance reduces the salaries of employees, output and excepted profit of the firm. More importantly, we illustrate that strong ability of the key person will promote the efficiency of employees. So this paper offers a full evaluation of firms’ purchase behavior of key person insurance and also develops the theory of key person insurance.

Introduction

Key person insurance, also called key man insurance, is an important form of business insurance. It is an insurance policy taken out by a business to protect from financial losses that would arise from the death or extended incapacity of a crucial member of the business. Key person insurance is necessary if the sudden loss of a key executive could have a significant negative effect on a company’s operations. In recent years an increasing number of insurance companies have started to offer key person insurance policies. Key persons have significant effects on a firm’s performance in the short-term. For example, in the case of Baidu.com Inc., owner of China’s most popular internet search site, the company’s shares fell sharply following the death of its chief financial officer (CFO), Shawn Wang, on Dec. 27, 2008. In the two days following his death, the share price fell 4.7%. In another case, when Steve Jobs, the co-founder, chairman and chief executive officer (CEO) of Apple, resigned from the company on Aug. 24, 2011, and then passed away on Oct. 5, 2011, there was a huge shock to the company’s stock (the share price fell 6% on the day after his death), which greatly affected the interests of investors. As we know, these sudden events have considerable effects on firms’ profits, and key person insurance can protect firms’ losses because these losses will be covered by the insurers. Therefore, key person insurance attracts attention from both firms and insurance companies because the risk for the key persons can be eliminated. Very few papers on key person insurance have been published. However, there is a vast literature on the effects of insurance on economic activities in industries and on the economy. For example, in microeconomics, Wang et al. (2017) and Pieper et al. (2015) addressed the effects of insurance on firms’ innovation in improving environmental quality. In industrial economics, competitive relationships between insurance companies and hospitals are discussed by Wang and Nie (2016), and the factors that affect the insurance industry have been confirmed by Biener et al. (2016). In macroeconomics, existing literature focuses on economic growth under insurance (Lee et al., 2016; Courbage and Rey, 2016; Nie, 2007; Eling and Schaper, 2017; Nie et al., 2016; Wang and Nie, 2018). Lee, Chang, Arouri & Lee (2016) recently examined the negative relationship between insurance and growth. Also, Bertrand & Prigent (2016) argued that insurance significantly impacts the equilibrium in portfolios, and they showed that the equilibrium risk-neutral density is equal to the product of a factor corresponding to the total risk tolerance with exogenous insurance constraint. Because life insurance relates to almost everyone, most of the literature highlights the effects of life insurance on human capital (Israelsen and Yonker, 2017; Nie, 2014; Dineen and Allen, 2016). Below we briefly introduce the related research about the effects of life insurance on human capital.

This paper evaluates the relation between amounts recognised as identifiable intangible assets in business combinations and acquisition premiums, in periods before and after transition to IFRS. In the pre-IFRS period there is evidence of firms recognising identifiable intangible assets in business combinations where high acquisition premiums are paid. This is consistent with opportunism in the recognition of identifiable intangible assets, and high acquisition premiums being an economic consequence of the relative latitude in accounting for identifiable intangible assets. This association of identifiable intangible assets with acquisition premiums ceased with transition to IFRS, notwithstanding the latitude that continues to be provided in accounting regulations for the recognition of identifiable intangible assets. However, the incentives for opportunism remain and an issue requiring address is whether alternative sources of accounting flexibility in relation to business combinations exist, such as goodwill which is no longer subject to mandatory amortisation.

Introduction

This paper evaluates the association of identifiable intangible assets (IIA’s) acquired and recognised in business combinations with acquisition premiums, and considers whether this relationship changed on transition to International Financial Reporting Standards (IFRS) in 2005.1 There is evidence that firms in Australia historically recognised IIA’s rather than goodwill in business combinations because this ameliorated the impact of the mandatory amortisation of goodwill on firm performance reported in subsequent periods (e.g. Wines and Ferguson, 1993). As a consequence, the recognition of IIA’s in business combinations is commonly labelled ‘opportunistic’. Consistent with this ‘opportunistic’ label, Su and Wells (2015) are unable to find evidence that amounts recognised as IIA’s in business combinations are associated with future performance. 2 This gives rise to the concern that an economic consequence of the relative latitude afforded to accounting for IIA’s is high acquisition premiums, which given the absence of a relation with future performance may indicate overpayment. Hence, the first objective of this paper is to evaluate whether there is evidence of an association between the recognition of IIA’s and acquisition premiums. With transition to IFRS in 2005, the requirement for mandatory amortisation of goodwill was removed and the opportunistic incentives to recognise IIA’s rather than goodwill diminished. Accordingly, the second objective of this paper is to evaluate if the association between IIA’s and acquisition premiums persists in periods after transition to IFRS. The first motivation for this paper is to determine if regulatory arbitrage in relation to accounting choices for business combinations contributes to high acquisition premiums, and potentially overpayment by acquiring firms. There is empirical evidence of firms overpaying in acquisitions for a range of reasons, including management hubris (Roll, 1986), management empire building (Jensen, 1986) and management needing to find new opportunities for growth after exhausting those available internally (McCardle and Viswanathan, 1994). Furthermore, there is evidence of firms ameliorating the impacts of business combinations on financial statements through accounting policy choices (Wines and Ferguson, 1993; Ayers et al., 2000). However, an issue requiring address is whether this contributes to high acquisition premiums and has economic consequences. Anecdotal evidence of IIA’s being associated with high acquisition premiums in business combinations, and potentially overpayment, is provided by firms such as ABC Learning Ltd (ABC). As a consequence of business combinations over the period 2000 to 2007 ABC recognised IIA’s (that were not amortised) of $2,622m, and goodwill (which was for most this period amortised) of only $269m. Any of the reasons identified above for overpayment, which would manifest in high acquisition premiums, could be considered relevant.

1- Introduction

2- Model framework

3- Contract valuation

4- Numerical analysis

5- Conclusion

References

Abstract

We study the risk-neutral valuation of participating life insurance policies with surrender guarantees when an early default mechanism, forcing an insurance company to be liquidated once a solvency threshold is reached, is imposed by a regulator. The early default regulation affects the policies’ value not only directly via changing the policies’ payment stream but also indirectly via influencing policyholder’s surrender. In this paper, we endogenize surrender risk by assuming a representative policyholder’s surrender intensity bounded from below and from above and uncover the impact of the regulation on the policyholder’s surrender decision making. A partial differential equation is derived to characterize the price of a participating policy and solved with the finite difference method. We discuss the impacts of the early default regulation and insurance company’s reaction to the regulation in terms of its investment strategy on the policyholder’s surrender as well as on the contract value, which depend on the policyholder’s rationality level.

Introduction

A typical participating life insurance policy provides policyholders with a minimum interest rate guarantee and bonus payments upon death and upon survival which are linked to the performance of the insurance company. Usually, additional options are embedded in the policies to increase their attractiveness to the policyholders, among which the most popular one is a surrender option. A surrender option entitles the policyholders to terminate their contract prematurely and to obtain the surrender benefits promised by the insurance company. The policyholders may not necessarily receive the payments specified in their contract even if they hold it until maturity. If the insurance company does not have enough reserves to pay back its liabilities at the maturity date, the policyholders cannot get more than what remains in the company. To protect the policyholders from collecting too few benefits as the insurance company declares bankruptcy at maturity, regulatory authorities impose early default mechanisms to monitor insurance companies’ financial status and close them before it is too late. For example, under Solvency II, the supervisory authority withdraws the authorization of an insurance company when its capital falls below the minimum capital requirement and does not recover within a short period of time, see Solvency II Directive (2009/138/EC). Also, an insurance company supervised by the Swiss Financial Market Supervisory Authority (FINMA) can lose its license when its risk-based capital drops below the lowest threshold specified in the Swiss Solvency Test (SST), see FINMA Circ. 08/44 SST, FINMA (2008). Proceeds from liquidated assets are then paid to stakeholders. Hence, the policyholders also face early default risk of the insurance company accompanied with the early default regulatory intervention.

Private information may limit insurance possibilities when two agents get together to pool idiosyncratic risk. However, if there is capital accumulation, bilateral insurance possibilities may improve because misreporting distorts investment. We show that if one of the Pareto weights is sufficiently large, that agent does not have incentives to misreport. This implies that, under some conditions, the full information allocation is incentive compatible when agents have equal Pareto weights. In the long run, either one of the agents goes to immiseration, or both agents’ lifetime utilities are approximately equal. The second case is only possible with capital accumulation.

Introduction

Private information limits insurance possibilities when two agents get together to pool idiosyncratic risk. We show that if their total income depends on capital accumulation and production, bilateral insurance possibilities improve because misreporting distorts investment. This occurs because cheating implies that the misrepresenting agent will receive higher utility today at the expense of reducing the other agent’s current consumption and of reducing investment. The latter reduces both agents’ continuation values, and it therefore provides incentives to prevent cheating. This mechanism is more significant when the agent’s Pareto weight is larger, as he cares more about the total level of capital in the economy. In the long run, either one of the agents is driven to immiseration, or both agents’ lifetime utilities are approximately equal. We show that the second case is only possible in economies with capital accumulation. We study the optimal bilateral insurance arrangement between two risk-averse agents facing preference shocks.1 We compare two alternative setups: (i) Agents share the ownership of production and investment (Capital Accumulation Economy, CAE), and (ii) Total income is constant and exogenous (Endowment Economy, EE). The optimal contract maximizes the weighted sum of the agents’ lifetime utility. Ideally, each agent’s consumption should depend on his preference shock. However, if shocks are private information, the optimal arrangement must also deal with incentives to misreport. Thus, private information may limit insurance capabilities. To understand the role of capital accumulation for incentives under private information, we show that there is a clear difference between the CAE and EE. In the EE, incentives to cheat exist because reporting a high-preference shock increases consumption of the reporting agent at the expense of reducing consumption of the other agent. Thus, unless promises about future consumption are modified as a function of the report, agents always want to report the highest value of the preference shock. In contrast, in the CAE, if an agent chooses to cheat, she will consume more this period at the cost (at least partially) of reducing investment, which will reduce her future consumption. We show that this force is more important for providing incentives for agents with larger Pareto weights, as they more strongly internalize the effect on future available resources. Thus, in addition to incorporating capital accumulation, it is crucial to consider a small number of agents. To the best of our knowledge, this result was not previously demonstrated or understood, because past work looked at only a continuum of agents or an endowment economy.2 We made two additional assumptions that help simplify the analysis: Agents are ex-ante identical, and the preference shock can be either high or low. Under these conditions we derive three key results as summarized by Propositions 1, 2, and 3. First, Proposition 1 shows that in the CAE an agent has no incentives to cheat under the full information allocation when his weight is above a threshold smaller than one. To understand this result, note that if an agent’s weight is equal to one, all the extra funds she receives after cheating are only “financed” by disinvestment because the consumption of the other agent is already zero. She also fully internalizes the effect of the investment distortion because given that her weight is one, she will receive all future output. Thus, she would be strictly worse off misrepresenting her preference shock when her weight is exactly one. Now, as a small change in the weight changes consumption and investment only slightly (by continuity of the full information allocation), cheating will not be desirable even if the weight were slightly smaller than one. Although this result demonstrates that at some point the incentives to cheat vanish completely, the numerical solution of the model suggests a more general interpretation. In the CAE, there is a force created by the behavior of investment in the full information allocation that helps provide incentives for truthful revelation, and this force is increasing in the value of the agent’s Pareto weight. In sharp contrast, Proposition 1 also shows that in the EE, if both agents have positive Pareto weights, their incentive compatibility constraints must be binding.

This paper estimates the impact of a health insurance reform on health outcomes in urban China. Using the China Health and Nutrition Survey we find that this reform increases the rate of health insurance coverage significantly among workers in Non-State Owned Enterprises. The double difference (DD) estimations show that the reform also leads to better health outcomes: workers are less likely to get sick and more likely to use preventive care. Using an instrumental variable (IV) approach to look at the causal effect of health insurance, we find those with health insurance use more preventive care but do not report significantly better health outcomes, an increase in health care utilisation, or an increase in out-of-pocket medical expenditure.

Introduction

Providing adequate health insurance to the majority of a country’s citizens in a cost-effective manner is a challenge faced by many countries. Given the uncertainty present in the market for health care and the lack of resources faced by individuals and governments in developing countries, the issue is even more acute for less-developed nations. Many developing countries are trying to use social insurance systems and payroll taxes to provide their citizens with equal access to health care (Hsiao & Fraker 2007). Indeed, around 50 percent of countries outside of the OECD finance the majority of health spending using public funds.1 In this paper we look at how China, one of the largest developing countries, expanded health care coverage to a significant proportion of its citizens working in urban areas and the effects that health care expansion had on self-reported health outcomes and the use of preventative care. The results outlined in this paper can provide insights for other large developing countries that are considering expanding health care coverage; the results show how health insurance, while being able to spread financial risks and prevent deprivation of care due to a patient’s inability to pay (Feldstein 2006), may lead to an increase in demand for services. In the early 1990s China had not established a comprehensive health insurance system for all of its citizens. In the urban areas, only employees of government-run facilities and Sate-Owned Enterprises (SOE) were covered. In rural areas, the old cooperative medical scheme had collapsed when the commune was broken up. The poor coverage in urban areas coupled with the downfall of rural coverage meant that the vast majority of the population did not have health care insurance; in fact, in 1998, only 9.5% of the rural population were insured (Liu 2004). Many people could not afford basic health care and families were suffering from high medical expenses (Watts 2006). China sought to remedy the failures in the health care market by introducing reform aimed at expanding insurance coverage to all employees: both those working in SOEs and the private sector. In 1999 a new social insurance system for all urban works was established. In 2003, China re-established the cooperative medical system in rural areas and health insurance was expanded to cover the non-employed, children, the disabled, poor, and aged in urban areas. By the end of 2011, the coverage rate had reached 95% of the population. This paper will focus on the first major expansion, the Urban Employees’ Basic Medical Insurance (UEBMI) Reform, that took place in 1999 and was the impetus for the rest of the health care reforms.