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How negative health shocks affect financial choices

by Jens Sørlie Kværner, Trond Døskeland & Kari J. Kværner
Posted on June 17, 2020

As we live longer in a world that's more and more globalized, we'll all experience a certain health risk at some point in our lives. Longer life expectancy thanks to advanced biotechnical research and treatment options means that more people will fully recover from previously fatal health shocks. Globalization, traveling, and international trade will continue to raise the pace at which new infectious diseases - like COVID-19 - spread. Given the prevalence of health shocks and their influence on variables typically tied to individuals’ and households’ financial decisions, it is important to understand how, when, and for whom such negative life events affect financial choices. And that's exactly what we focus on in our research.

The negative life events we picked for our study are cancer diagnosis and widowhood. Both events can influence labour market outcomes and individuals' well-being, with potential spillover effects on financial decision-making. Both events are common and may affect everyone: men and women, young and old, rich and poor. Recent prognoses indicate that half of those under 65 years of age today will eventually experience cancer.

Research challenges

The literature on the importance of health in financial decision-making, such as how much to invest in the stock market, has struggled with two challenges: the unavailability of large-scale household-level data on health, family links, and financial outcomes, and the difficulty of isolating the causal effects of health shocks in the presence of complex dynamics and systematic measurement error. Systematic measurement error may reflect a justification bias: respondents may report a worse subjective level of health to justify their current economic status. As a result, solely relying on subjective measures of health status and self-reported measures of wealth is unsatisfactory.

In our study, we tackle these challenges. We are particularly pleased with our dataset, which is the result of merging anonymized individual medical records with administrative data on financial and demographics for the Norwegian population from 2005 to 2013. Thanks to this individual-level data, we are able to investigate how financial decision-making depends on the severity of cancer, cancer type, age, education, family income, and financial commitments such as debt prior to the diagnosis.

Furthermore, we develop a simple identification strategy to deal with confounding. For example, smoking can affect both cancer and financial choices. However, such confounding is cancelled out by identifying the effect of treatment from the difference in financial choices between households affected today and households affected a few years later.

Finally, because all costs related to the cancer treatment are covered in Norway, the investment behaviour we identify reflects individuals' responses to the negative life event itself, including mental and somatic aspects, and income effects.

“Losing a spouse has a big negative impact on a household’s expected income and decreases consumption levels”

Preliminary results

The analysis of about 70,000 households - over a period of 7 years in which one household member experiences cancer or widowhood - allows us to draw three main conclusions:

1. A cancer diagnosis increases the likelihood of exiting the stock market two to three years after the diagnosis, but it does not affect the composition of the financial wealth of those that stay in the stock market.

2. Widowhood increases the probability of a stock market exit by a factor of nine relative to non-fatal cancer, and increases the likelihood of being financially constrained.

This is in line with our expectations: losing a spouse has a big negative impact on a household’s current and expected income, which in turn forces the household’s consumption closer towards a minimum consumption level. It also makes the household’s consumption more dependent on other income sources. In order to reduce the increase in sensitivity towards asset price fluctuations, the household takes less risk.

The third conclusion is based on our analysis of historical records, which allowed us to investigate whether personal experience with cancer (many up to 10 years ago) is associated with stock market participation and composition of financial wealth.

3. We do not find any relation between having dealt with cancer in the past and current financial choices. In the same way as patients recovering from cancer will resemble non-cancer households on many sociodemographic variables, the portfolio choice of households with cancer experience will be similar to non-diagnosed households. We interpret this as evidence of forward-looking behaviour that is likely to benefit households.

Our findings suggest that cancer leads to short-term changes in circumstances such as labour income prospects and liquidity, which influences financial portfolio choices. In the long-term, these imbalances fade away, and "diagnosed" households choose similar portfolios as non-diagnosed peers.

Upcoming research

We plan to continue our research in several directions. First and foremost, we want to evaluate the external validity of this study; we need to find out whether our results hold outside Norway, and across diseases. We also plan to study not only whether negative health shocks affect financial choices, but also why they do so. We hypothesize four key factors: mortality, wages, medical expenditures, and the ability to work.

Another direction our research will take us, is about illustrating that negative health-related lifetime events can lead to a large reduction in family income and increase the likelihood of being liquidity constrained. Building on these insights, we plan to investigate the effect on health shocks on personal bankruptcy. Here we are interested in identifying the key variables that explain variation in realized bankruptcy for a given health shock, like cancer.

Finally, we plan to build an economic model that helps us understand the quantitative importance of our findings and whether current insurance products are sufficient to fully insure against the financial consequences of these health shocks.

We hope our research will convince policymakers and insurance companies to come up with standardized health insurance products that are automatically optimized throughout life, as retirement accounts often are.

Our follow-up study, planned to start early 2021, will use data from the Netherlands. We have already secured access to a rich dataset covering more than 500 distinct diseases, which we can merge with administrative data on financial, demographic characteristics, and various credit metrics for the entire Dutch population for over 10 years. We are excited about what we will discover.

Jens Sørlie Kværner is Assistant Professor at Tilburg University

Trond Døskeland is Professor at NHH, Norwegian School of Economics

Kari J. Kværner is Adjunct Professor at BI Norwegian Business School