Most individual life insurance policies lapse, with lapsers cross-subsidizing non-lapsers. We show that policies and lapse patterns predicted by standard rational expectations models are the opposite of those observed empirically. We propose two behavioral models consistent with the evidence: (i) consumers forget to pay premiums and (ii) consumers understate future liquidity needs. We conduct two surveys with a large insurer. New buyers believe that their own lapse probabilities are small compared to the insurer’s actual experience. For recent lapsers, forgetfulness accounts for 37.8 percent of lapses while unexpected liquidity accounts for 15.4 percent.

We study contracts between naive present‐biased consumers and risk‐neutral firms. We show that the welfare loss from present bias vanishes as the contracting horizon grows. This is true both when bargaining power is on the consumers' and on the firms' side, when consumers cannot commit to long‐term contracts, and when firms do not know the consumers' naiveté. However, the welfare loss from present bias does not vanish when firms do not know the consumers' present bias or when they cannot offer exclusive contracts.

This paper proposes a perfectly competitive model of a market with adverse selection. Prices are determined by zero-profit conditions, and the set of traded contracts is determined by free entry. Crucially for applications, contract characteristics are endogenously determined, consumers may have multiple dimensions of private information, and an equilibrium always exists. Equilibrium corresponds to the limit of a differentiated products Bertrand game. We apply the model to establish theoretical results on the equilibrium effects of mandates. Mandates can increase efficiency but have unintended consequences. With adverse selection, an insurance mandate reduces the price of low-coverage policies, which necessarily has indirect effects such as increasing adverse selection on the intensive margin and causing some consumers to purchase less coverage.

This paper studies the value of more precise signals on agent performance in an optimal contracting model with endogenous effort. With limited liability, the agent’s wage is increasing in output only if output exceeds a threshold, else it is zero regardless of output. If the threshold is sufficiently high, the agent only beats it, and is rewarded for increasing output through greater effort, if there is a high noise realization. Thus, a fall in output volatility reduces effort incentives—information and effort are substitutes—offsetting the standard effect that improved information lowers the cost of compensation. We derive conditions relating the incentive effect to the underlying parameters of the agency problem.

The informativeness principle states that a contract should depend on informative signals. This paper studies how it should do so. Signals indicating that the output distribution has shifted to the left (e.g., weak industry performance) reduce the threshold for the manager to be paid; those indicating that output is a precise measure of effort (e.g., low volatility) decrease high thresholds and increase low thresholds. Surprisingly, “good” signals of performance need not reduce the threshold. Applying our model to performance-based vesting, we show that performance measures should affect the strike price, rather than the number of vesting options, contrary to practice.