Thursday, January 10, 2013

Why is barely anyone buying annuities?

I have written before about the fact that so few people take annuities upon their retirement. While several reasons have been proposed, the literature has dealt with them in isolation, which is not very useful.

Svetlana Pashchenko addresses all suggestion in one swoop by using a quantitative life-cycle model with uncertain lifetime and medical expenses, bequest motives and minimum guaranteed consumption. Calibrated to the US, the model determines four equally important factor that prevent annuities from becoming popular: 1) pre-annuitized wealth (pensions), 2) minimum annuity size, 3) illiquid housing wealth, and 4) bequest motives. Pricing of annuities, interestingly, is not a factor. Adverse selection is responsible for making them more expensive than actuarially fair, while it decreases annuity demand for the poor, it increases it for the rich (as they know they will live longer and have cash to buy annuities). Note that 3) is another puzzle to me, as reverse mortgages are also rare, and they would render housing wealth liquid.

1 comment:

Joseph Kaupp said...

I've seen some other papers on this issue, a number of which have attributed the low rate of annuities to the payout risk associated with an unknown date of death. Brown et al. (2008) have a nice, concise paper, which states that the perceived value of an annuity largely depends upon whether individuals are considering the asset from a consumption or a risk/return point of view.

Thanks for posting this paper. This is far and away more informative than some of the others I've looked into.