The Demand for Life Insurance: An Application of the Economics of Uncertainty

ABSTRACT Financial economists typically assume that capital income uncertainty, derived from investments in uncertain returned marketable securities, represents the major source of household consumption uncertainty. But, for many households, if not most, labor income uncertainty dominates capital income uncertainty. This study analyzes households optimal reactions to labor income (human capital) uncertainty that is derived from the possibility of their wage earners' non–survival. By introducing a risk resolution mechanism—an insurance market—and allowing for the possibility that future tastes may be state–dependent, simple demand–for–insurance equations are mathematically derived to explicitly describe households optimal responses to human capital uncertainty.