Guessing, math, or something else? Lay people's processes for valuing annuities

Abstract

AbstractResearchers have long been trying to understand why individuals dislike annuities. Here, we investigate if the process individuals use to assess the financial value of annuities may lead them to inaccurately value annuities. In Study 1, participants were asked to assess the monthly payments associated with a specific annuity lump sum or the annuity lump sum associated with a specific monthly payment. They were then asked to describe how they arrived at their answers. We find that when making this assessment, 42% of participants report attempts at using math, with some even describing mathematical formulas. Most other participants reported guessing instead. Reporting attempts at math is more common among participants with higher financial literacy and numeracy. Reported attempts at math, financial literacy, and numeracy predict arriving at more realistic financial values for annuities, as well as incorporating assessments of life expectancy in the math. Based on this process knowledge, we then designed an experiment in Study 2 and tested the effect of presenting information about life expectancy, providing feedback about payouts or their combination. We find that we can thereby change the assessed financial value of annuities and increase participants' interest in annuities, especially among participants that reported attempts at using math. Understanding the processes individuals use to assess the value of annuities informs theory and practice.