The Effects of Survival Probabilities, Transactions Cost and the Attitude Towards Risk on the Demand for Annuities

Abstract

Uncertain lifetimes induce two different types of insurance markets: (a) annuity, and (b) life insurance. The annuity market differs crucially from the life insurance market in two important respects: (1) The demand for (term) life insurance will be generated by a bequest motive; (2) the demand for life insurance will be positive if the decision-maker (dm) chooses to borrow against future income streams. On the other hand, intertemporal decision making with uncertain lifetimes alone is a strong enough motivation for the existence of an annuity market. In this paper, we shall investigate how survival probabilities (and longevity), transactions cost and attitude towards risk affect the demand for annuities. Some of the results are counter-intuitive. These results need not carry over to the life insurance market because of the fundamental differences between an annuity and the life insurance. The paper is organized as follows: section II lays out the basic two period framework in which the analysis is carried out in section III. Section IV concludes with a discussion of our results and directions for future research.