Are annuities an inferior or normal good? Evidence from a less-developed country

Abstract

One crucial decision made at retirement in Chile is whether to acquire an annuity or a phased withdrawal (PW) scheme. Annuities, unlike PW, do not allow for inheritance and provide smaller initial pension benefits while protecting against longevity and capital market risks. If preferences show decreasing absolute risk aversion (DARA), then an annuity (insurance) should be considered an inferior good. We test this hypothesis on Chilean data using a binary choice model. Our results reject the DARA hypothesis for the whole sample. However, after splitting the sample into low- and high-income groups, we find that the former have increasing absolute risk aversion (IARA) behavior, whereas the latter have DARA behavior. These findings suggest that policy programs encouraging retirement savings, such as tax breaks and subsidies, should be approached with caution depending on the balance of high and low-income individuals, particularly in less-developed economies.