Annuitization Rates Research Articles

How default effects and decision timing affect annuity uptake and health consciousness

Annuities provide a lifelong income stream and can therefore help individuals to mitigate the risk of outliving their savings, a highly topical issue in the context of increasing life expectancies. Given that real-world annuitization rates remain relatively low, we investigate the influence of behavioral biases on people’s choice between a lifelong annuity and a lump sum payout. In so doing, we focus on the impact of default effects due to a preselected annuity option (default option) and the impact of the decision’s timing (decisions on annuitization taken by younger individuals refer to a distant future, those taken by older individuals to a near future) on annuity uptake and health consciousness. We used a scientific survey panel to conduct an online experiment with a diversified sample of 339 participants (55.2% female, average age = 42.5 years). Our results show that the timing of the decision moderates the default effect on annuity uptake, in that the effect of a preselected (default) annuity option is stronger for distant-future decisions (i.e., choice of annuity instead of lump sum at retirement made by younger participants purchasing a deferred annuity) than for near-future decisions made by older individuals who are closer to retirement. We further find that the default effect moderates health consciousness after choosing an annuity. Health consciousness is stronger in the no-default condition than in the annuity default condition.

The United States Longevity Insurance Market

This chapter documents the substantial decline in traditional sources of longevity insurance, and shows that published statistics on the individual annuity market greatly overstate its size and growth. It considers whether the decline in annuitization rates is cause for concern. It then documents in more detail the structure, size, and pricing of the individual annuity market, and discusses product innovations. It concludes by discussing policy options for increasing rates of voluntary annuitization.

Pension Plan Distributions: The Importance of Financial Literacy

This chapter examines workers’ plans to take lump sum distributions versus life annuities from employer retirement plans. The analysis is based on before and after surveys of retirement eligible workers who attended employer-provided retirement planning seminars. We consider workers’ planned distributional choices from both defined benefit and 401(k) plans. A minority of respondents plan to take the non-default options, highlighting the importance of framing. Additionally, higher financial literacy is associated with lower rates of annuitization in both plans. We explore how participants change their planned distribution choices after attending seminars that enhance financial knowledge and understanding of retirement plans.

What Do We Know About Annuitization Decisions?

AbstractAgainst the background of aging societies and increasing life expectancies, the protection of individuals from outliving their savings has become increasingly relevant. Annuities represent insurance against longevity risk and can prevent old‐age poverty. The aim of this article is to present the current state of theoretical, empirical and experimental evidence with regard to annuitization decisions. Toward this end, we conduct a systematic literature review that includes 89 articles. Based on this, we study welfare effects of mandatory annuitization, annuitization rates and the optimal fraction of wealth to be annuitized, as well as determinants of retirees’ choice to annuitize and their impact on annuity demand. Finally, we present possible solutions for overcoming the low uptake of annuities based on its causes. One main result is that behavioral biases in annuitization decisions particularly require considerably more theoretical research and empirical evidence, and that theoretical models already appear to well explain empirically observed annuitization rates.

An Experimental Analysis of Annuity Aversion the Role of Framing and Uncertainty

To understand the factors that influence people in their retirement decisions is of great importance. Due to an ongoing shift in western societies from public to private pension systems it becomes more and more the task of individual retirees to insure against longevity risk. While economic theory suggests that annuities should account for large parts of a retiree’s income, only few retirees include private annuities in their retirement portfolio at all. Empirical data on what drives this annuity aversion is limited, so we suggest using laboratory experiments to test possible explanations for the low rates of annuitization. We propose an experimental setup and provide a possible framework for future experimental research in the context of annuities. In a first application, we use this framework to test the influence of framing and lifetime uncertainty on annuity aversion.

The Empirical Frame of the Decision to Annuitize

Microeconomic theory suggests that annuities are favorable because they ensure a steady path of consumption no matter how long the annuitant will live. As a promising attempt to explain why actual annuitization rates are lower than expected, it has recently been argued that consumers do not use such a consumption frame when they decide on annuitizing their wealth. Instead, they might rather apply an investment frame: They evaluate the annuity as a standalone financial product, focusing mainly on its risk and return characteristics and thereby ignoring its insurance value. In this paper, we propose a novel approach to empirically test which frame is actually used by consumers. More precisely, we argue that uncertainty about one’s subjective prospects of survival should have opposing effects on the decision to annuitize depending on the frame. In a consumption frame, an annuity provides a hedge against the financial risks of an uncertain lifetime whereas in an investment frame uncertainty about one’s future survival translates directly into financial risk. Using field data from the Health and Retirement Study, we show that respondents who have more precise beliefs about their chances of survival tend to annuitize larger parts of their wealth. We therefore find empirical support for the investment frame.

Assessing the Demand for Annuities in an Undeveloped Market: Evidence from Hong Kong

textabstractHow to design an attractive annuity for an undeveloped market and how to assess the potential demand for such a product? We first conduct a discrete choice experiment among participants of a large-scale occupational defined contribution pension scheme in Hong Kong to identify desired product characteristics of an annuity. The preferred annuity is sold by an A-rated insurance company, provides nominal annuity payouts and a 10-year period-certain guarantee. Using a second survey, we then analyze the demand for the preferred annuity. Close to one third of respondents chooses to annuitize, a fraction that considerably exceeds observed annuitization rates in developed markets. Regarding household characteristics, we find that annuity demand decreases with general financial literacy but increases with specific knowledge about the annuity product. Remarkably, a self-reported bequest motive increases the demand for an annuity providing a 10-year period-certain guarantee.

Time inconsistent preferences and the annuitization decision

When entering retirement, many people face the decision of whether they would like to receive their defined contribution account balance as a lump sum distribution or to annuitize the amount. The fact that people tend to choose a lump sum distribution even if economic reasons suggest otherwise is called the “annuity puzzle.” The results of a large online survey show that people behave in a time inconsistent manner: older people have a stronger tendency to choose the lump sum than younger people. This effect, and therefore, the low real life annuitization can be explained by hyperbolic discounting. The age effect is considerably stronger for participants that answer simple time preference questions inconsistently. Our findings suggest that commitment devices can help to increase annuitization rates.

Do Retired Americans Annuitize Too Little? Trends in the Share of Annuitized Income

This paper examines the importance of annuity-like income as a share of total money income received by aged families. The analysis considers the aged (62) population as a whole as well as different parts of the aged families’ income distribution during the period from the early 1980s through 2009. We use survey data from 1983 through 2009 from the March Current Population Survey (March CPS) and the Survey of Consumer Finances (SCF). The total income amounts reported in the files are compared with data in the National Income and Product Accounts (NIPA). We calculate the family income consisting of annuitized income flows (primarily Social Security and pensions) and measure it as a share of families’ total money income. We also expand the definition of both annuitized and non-annuitized income to include income flows not captured in the surveys, namely, health insurance subsidies and the housing services received by homeowners. Finally, we consider the potential impact on aged families if they were to convert their wealth into private annuities.The paper finds that:-- Despite the shift from defined benefit (DB) to defined contribution (DC) retirement plans, there is little evidence that the annuity-like income share of total income has fallen for aged families – and, in particular, for low-income aged families – over the past three decades.-- This basic result remains unchanged when we consider more comprehensive income definitions and when we focus on aged families with retired heads of family.-- Nonetheless, many middle- and high-income aged families would experience a sizeable increase in monthly income if they annuitized their wealth. The policy implications of the findings are:-- Concerns that reduced rates of annuitization will lead retirees to spend down their assets at a too-rapid rate seem overblown or at least premature; there is little evidence that the share of income derived from annuity-like income sources has declined.-- Contrary to a widespread fear, the shift from DB to DC workplace pensions has not reduced the share of retirement income that consists of relatively secure, annuity-like income flows that will last as long as aged breadwinners and their spouses survive.

A Piece of the Annuitization Puzzle: The Role of Plan Rules in Annuitization Decisions in DB and CB Plans

In spite of the valuable longevity insurance annuities provide, actual annuitization rates of retiree wealth remain low. Previous studies investigating what economists term the “annuity puzzle” have focused on workplace pension plans because they offer a choice between an annuity and a lump-sum distribution. These studies found large variations in annuitization rates among employer-provided defined-benefit (DB) and cash-balance (CB) plans but did not provide a concise explanation. This article does provide an explanation—in particular, variations in plan rules can explain the variation in annuitization rates. The rates vary directly with the degree of restriction imposed on lump-sum distributions. Plans with no option for a lump-sum distribution have annuitization rates of close to 100%, whereas plans with no restrictions on lump-sum distributions have annuitization rates of between 20% and 40%. Given an unrestricted choice, only a minority of plan participants choose an annuity. <b>TOPICS:</b>Retirement, pension funds

Analysis of payout choice from individual deferred annuities in Korea

AbstractWe analyse annuitization rates by policyholders with individual deferred annuities in Korea to assess the impact of different tax policies on payout decisions between 2008 and 2011. Under the Korean tax system, two types of individual deferred annuities were sold: qualified (taxed for lump sums) and non-qualified (tax free for lump sums). Our results show that policyholders with qualified contracts are more likely to select a life annuity option than a lump-sum distribution, compared to policyholders of non-qualified contracts. This suggests that policyholders are more likely to use non-qualified contracts as savings vehicles than as longevity insurance.

How Much Do Means-Tested Benefits Reduce the Demand for Annuities?

We analyze the effect of means-tested benefits on annuitization decisions. Most industrialized countries provide a subsistence level consumption floor in old age, usually in the form of means-tested benefits. The availability of such means-tested payments creates an incentive to cash out (occupational) pension wealth for low and middle income earners, instead of taking the annuity. Agents trade-off the advantages from annuitization, receiving the wealth-enhancing mortality credit, to the disadvantages, giving up, “free,” wealth in the form of means-tested supplemental benefits. We find that the availability of means-tested benefits can reduce the desired annuitization levels substantially. Using individual level data, we show that the model’s predicted annuitization rates as a function of the level of pension wealth are roughly consistent with the cash-out patterns of occupational pension wealth observed in Switzerland.

How Much Do Means-Tested Benefits Reduce the Demand for Annuities?

We analyze the effect of means-tested benefits on annuitization decisions. Most industrialized countries provide a subsistence level consumption floor in old age, usually in the form of means-tested benefits. The availability of such means-tested payments creates an incentive to cash out (occupational) pension wealth for low and middle income earners, instead of taking the annuity. Agents trade-off the advantages from annuitization, receiving the wealth-enhancing mortality credit, to the disadvantages, giving up “free” wealth in the form of means-tested supplemental benefits. We find that the availability of means-tested benefits can reduce the desired annuitization levels substantially. Using individual level data, we show that the model’s predicted annuitization rates as a function of the level of pension wealth are roughly consistent with the cash-out patterns of occupational pension wealth observed in Switzerland.

Payouts in Switzerland: Explaining Developments in Annuitization

Switzerland is one of the few countries with long-term experience on withdrawal decisions made by retirees in fully-funded pension plans. Switzerland is also atypical in its unusually high annuitization rates, and indeed, a majority of retirees covered by mandatory occupational pension plans chooses an annuity at retirement. This chapter revisits the historical role of occupational pension plans in the provision of old age income, and examines the role of regulation in the payout phase. Recent developments in both market conditions and regulations are used to assess the impact of certain determinants of the annuitization decision, such as money’s worth ratios, means-tested benefits and behavioral factors.

Evaluating the Advanced Life Deferred Annuity — An annuity people might actually buy

Although annuities provide longevity insurance that should be attractive to households facing an uncertain lifespan, rates of voluntary annuitization remain extremely low. We evaluate the Advanced Life Deferred Annuity, an annuity purchased at retirement, providing an income commencing in advanced old age. Using numerical optimization, we show that it would provide a substantial proportion of the longevity insurance provided by an immediate annuity, at much lower cost. At plausible levels of actuarial unfairness, households should prefer it to both immediate and postponed annuitization and an optimal decumulation of unannuitized wealth. Few households would suffer significant losses were it used as a 401(k) plan default.

Pension Payouts in Chile: Past, Present, and Future Prospects

One of the most interesting features of the Chilean pension system is that approximately two-thirds of all retirees purchase annuities, resulting in annuitization rates much higher than in other countries. In this paper we review recent developments in the payout market for Chilean pensions, focusing particularly on the role of annuities, and we discuss what makes the payout market in Chile so different from those in other nations.

Evaluating the Advanced Life Deferred Annuity: An Annuity People Might Actually Buy

Although annuities provide longevity insurance that should, in theory, be attractive to risk-averse households facing an uncertain lifespan, rates of voluntary annuitization remain extremely low. We evaluate a proposed annuity product, the Advanced Life Deferred Annuity, an annuity purchased at retirement, providing an income commencing in advanced old age. Using numerical optimization techniques, we show that this product would provide a substantial proportion of the longevity insurance provided by an immediate annuity, at a small fraction of the cost. At plausible levels of actuarial unfairness, households should prefer it to both immediate and postponed annuitization, and an optimal decumulation of unannuitized wealth. We show that few households would suffer significant losses were it used as a 401(k) plan default.

Reform Model Two of the President's Commission to Strengthen Social Security: Distributional Outcomes Under Different Economic and Behavioral Assumptions

This project uses dynamic microanalytic simulation techniques to explore the distributional consequences of Plan 2 of the President's Commission to Strengthen Social Security. This plan includes a voluntary personal account that would be carved out of currently-scheduled benefit contributions, a new minimum benefit, and an increase in widow(er)s benefits. It also shifts the current wage-indexed initial benefit formula to a price-indexed formula to address most of the current system's long-term solvency problem. The analysis begins by adopting the assumptions of the Office of the Chief Actuary (OCACT) regarding portfolio allocation, rates of return, administrative costs, and mandatory annuitization of personal account balances to develop a baseline of Model 2. We compare the distributional results with current-law promised benefits and a current-law scenario adjusted to match the revenues we estimate are required to fund the OCACT baseline in 2050 exclusive of the private account provisions. Subsequently, we test the sensitivity of our baseline estimates to different assumptions about participation in personal accounts, investment patterns, administrative costs, variation in market returns across the life cycle, and rates of return on investments. To simulate likely participation patterns in voluntary private accounts and participants' portfolio allocation choices, we estimate models using recent data from the Survey of Consumer Finances. The results from our core and sensitivity analyses bracket the likely outcomes of the reform plan and demonstrate how this type of reform might affect subgroups of the future elderly population.

The choice between an annuity and a lump sum: Results from Swiss pension funds

This paper uses unique micro data from Swiss employer-based pension plans to study the annuitization decision at retirement. The administrative nature of our data, though limited with respect to individual background characteristics, allows us to analyze real choices over large retirement balances, rather than subjectively reported intentions to annuitize. We find a strong and robust impact of a utility-based measure of the annuity's value (computed within a life-cycle framework) on individual annuitization rates. Low accumulation of retirement assets is strongly associated with the choice of the lump sum, presumably due to the availability of means-tested social assistance. The sponsor's default option, in most cases the annuity, is also found to be highly influential in the decision to annuitize.

Overview of the Issue

The second issue of the fifth volume of the JPEF features 4 research articles, and a book review section. The first article is by Estelle James, Guillermo Martinez and Augusto Iglesias and looks at: “The payout stage in Chile: Who annuitizes and why?” Low rates of voluntary annuitization are a major issue in defined contribution pension designs. Yet, in Chile, about 2/3 of individuals choose to annuitize instead of taking programmed withdrawals. The paper examines the reasons for this high rate of annuitization and concludes that it is due to the combination of a competitive market in annuities and the relatively constrained alternatives available to individuals. The paper nevertheless finds some evidence of adverse selection in the Chile annuity market.