Striking the Balance: Life Insurance Timing and Asset Allocation in Financial Planning

ArXiv ID: 2312.02943 “View on arXiv”

Authors: Unknown

Abstract

This paper investigates the consumption and investment decisions of an individual facing uncertain lifespan and stochastic labor income within a Black-Scholes market framework. A key aspect of our study involves the agent’s option to choose when to acquire life insurance for bequest purposes. We examine two scenarios: one with a fixed bequest amount and another with a controlled bequest amount. Applying duality theory and addressing free-boundary problems, we analytically solve both cases, and provide explicit expressions for value functions and optimal strategies in both cases. In the first scenario, where the bequest amount is fixed, distinct outcomes emerge based on different levels of risk aversion parameter $γ$: (i) the optimal time for life insurance purchase occurs when the agent’s wealth surpasses a critical threshold if $γ\in (0,1)$, or (ii) life insurance should be acquired immediately if $γ>1$. In contrast, in the second scenario with a controlled bequest amount, regardless of $γ$ values, immediate life insurance purchase proves to be optimal. Finally, we extend the analysis to consider a scenario in which the individual earmarks part of her initial wealth for inheritance, where a critical wealth threshold consistently emerges.

Keywords: Life insurance optimization, Duality theory, Free-boundary problems, Labor income, Bequest planning, Life Insurance / Wealth Management

Complexity vs Empirical Score

• Math Complexity: 8.0/10
• Empirical Rigor: 2.0/10
• Quadrant: Lab Rats
• Why: The paper is dense with advanced mathematics, featuring stochastic control, free-boundary problems, and duality theory, but lacks any empirical backtesting, datasets, or implementation details, focusing purely on theoretical analytical solutions.

  flowchart TD
    A["Research Goal"] --> B["Methodology"]
    B --> C["Problem Framework"]
    C --> D{"Bequest Structure"}
    D --> E["Fixed Bequest Amount"]
    D --> F["Controlled Bequest Amount"]
    E --> G["Analytical Solution via Duality & Free-Boundary"]
    F --> G
    G --> H{"Key Finding: Optimal Insurance Timing"}
    H --> I["Fixed Bequest: Wealth Threshold if γ < 1<br>Immediate Purchase if γ > 1"]
    H --> J["Controlled Bequest: Immediate Purchase<br>for all γ"]