Human Capital Risk, Contract Enforcement, and the Macroeconomy∗

We use data from the Survey of Consumer Finance and Survey of Income Program Participation to show that young households with children are under-insured against the risk that an adult member of the household dies. We develop a macroeconomic model with human capital risk, limited pledgability of human capital (limited contract enforcement), and age-dependent returns to human capital investment. We show analytically that, consistent with the life insurance data, in equilibrium young households are under-insured against human capital risk – they choose to use marginal resources for consumption or investment rather than purchase insurance. A calibrated version of the model can quantitatively account for the life-cycle variation of life-insurance, financial wealth, earnings, and consumption observed in the US data. Our analysis implies that a reform that makes consumer bankruptcy more costly, like the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, leads to a substantial increase in the volume of both credit and insurance.