The purpose of this paper is to test the effect of principle economic variables on lapse and surrender rate for life insurance using the Korean data from the first quarter of FY1998 to the first quarter of FY2008. We employ the explanatory as the economic variables and the dependent variables as the lapse and surrender rate. We examine the following three hypotheses: (i) the emergency fund hypothesis, which asserts that the lapse rate increases when the unemployment rate grows; (ii) the interest rate hypothesis, which suggests that the lapse rate grows when the market interest rate increases because keeping insurance contracts cause the opportunity cost to increase and (iii) the inflation hypothesis, which claims that the lapse rate grows when the rise in consumer price index decreases the real value of claim amount.
The empirical results support the emergency fund hypothesis, the interest rate
hypothesis, and the inflation hypothesis. In particular, this study indicates that
there is a statistically significant relationship between the lapse rate and GDP
growth rate, the growth rate of disposal income, unemployment rate, market
interest rate, and the growth rate in consumer prices and that the explanation
power of the model is high as indicated by the high adjusted R squared value.
Taking into account that there could be the contemporaneous correlation among the types of life insurance products, we also use the seemingly unrelated regression(SUR) model. The empirical results show that there is a statistically significant relationship between the lapse rate and unemployment rate, market interest rate, and the growth rate in consumer prices.
Our empirical findings suggest that the information of unemployment rate,
market interest rate and consumer price index should be reflected in estimating the lapse rate, and represent that the lapse rate estimated using economic variables could be used in establishing the portfolio strategy, marketing strategy and client management strategy.