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CORPORATE | 06.18.2020

Who is Franco Modigliani and what does he have to do with Life insurance?

 

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Franco Modigliani, an Italian-American economist, received the Nobel Prize in Economics for his studies on microeconomics, especially for his life-cycle hypothesis—which originated in Keynes’s work—and for his analysis of how financial markets operate. 

More specifically, the life-cycle hypothesis suggests that individuals plan their consumption and savings behavior over the course of their lives and, for that reason, MAPFRE Economics uses it as a catchy way to explain its relationship with Life insurance.

In its report entitled “Elements for the development of Life insurance,” MAPFRE Economics explains that, from an economic perspective, and taking into consideration its dimension as a means of channeling medium- and long-term savings, the development of Life insurance is linked to the ability of individuals to generate savings. “In this sense, the life-cycle hypothesis put forward by (…) Franco Modigliani provides a good perspective on how Life insurance can be coupled with this ability to generate savings over a lifetime,” explain the MAPFRE Economics economists.

Modigliani’s study concludes that, during their economically active period, individuals save and accumulate capital that they use during their retirement. As included in the MAPFRE Economics report, life can be divided into three stages. The first stage is the pre-work life stage; the second is the working life stage itself; and the third is the retirement stage once the cycle of productive activity has come to an end.

 

In the first of these stages (the initial stage of life), the individual’s level of income is lower than consumption needs, which are financed through loans or transfers from family, generating a phase of dis-saving. In the second stage, that of working life, the individual’s income allows them not only to meet their consumption needs, but also to generate a surplus in the form of savings. Finally, in the third stage, the retirement stage, there is again a process of dis-saving, in which the individual uses the savings that were generated throughout their working life (once the compensation for the initial stage of dis-saving has been discounted) to meet their consumption needs.

In conclusion, Modigliani’s diagram is useful for rationalizing the way in which Life insurance, as means of channeling medium- and long-term savings, can be incorporated into the individual’s life cycle (and prove to be very useful), especially in the stages of savings generation and dis-savings in the retirement stage. “Furthermore, this microeconomic vision supports the analysis of the impact that Life insurance has on the process of saving and investing in the economy, insofar as it generates a stable and long-term supply of resources in financial markets, thereby supporting the process of generating capital,” they conclude at MAPFRE Economics.