How Do Retirees Value Life Annuities? Evidence from Public Employees

Abstract

Because life annuities can increase the level and decrease the volatility of lifetime consumption, economists have long been puzzled by the low demand for life annuities. One potential rational explanation is that adverse selection drives up life annuity prices, which drives down demand. We study the choice between life annuities and lump sums made by 32,000 retiring public employees. These unique data allow us to extend the existing literature by exploiting economically significant cross-sectional and time-series variation in life annuity pricing. We find little evidence that retiree demand for life annuities rises when life annuity prices fall. We find strong evidence that demand responds to salient variation in individual characteristics, such as health, and to measures of investor sentiment, such as recent equity returns.