Document Type
Working Paper
Date of this Version
5-1-2009
Abstract
The wide gulf between actual and predicted annuity demand has been well documented. However, a comparable gap exists between the current and ideal annuity market. In a world with costly and limited annuity products, we investigate what types of new annuity products could improve annuity market participation and increase individual welfare. We find that participation gains are most likely for new annuity products that focus on late-life payouts which offer a large price discount relative to their financial market analogues. For example, the marginal utility from the first dollar allocated to a late-life annuity can be several times that of an immediate annuity. Our welfare analysis indicates that an individual’s current assets suggest desirable new annuity products since annuities that lower the cost of the existing consumption plan necessarily improve welfare. Finally, we consider the implications for annuity demand if new annuity products ultimately complete the annuity market. Given access to a complete market, we find all individuals only purchase annuity contracts with a significant time gap between purchase and payout. At a minimum, enough time must pass between purchase and payout to build up a mortality discount sufficient to overcome the cost of creating the contract. Since most existing annuity products, such as immediate annuities, do not have this feature, few current annuity contract configurations are likely to survive significant product innovation. Taken together, our results indicate that there is ample opportunity for innovation to spur annuity demand and improve individual welfare.
Keywords
Annuities, annuitization, Social Security, pensions, longevity risk, insurance
JEL Code
D11, D91, E21, H55, J14, J26
Working Paper Number
WP2009-03
Copyright/Permission Statement
Opinions and errors are solely those of the author and not of the institutions with whom the author is affiliated. © 2009 Pension Research Council of the Wharton School of the University of Pennsylvania. All rights reserved.
Acknowledgements
The authors thank William Sharpe, Geert Bekaert, Steve Grenadier, and Jim Shearer for many excellent comments and suggestions. Any remaining errors or omissions are the authors' responsibility. The views expressed herein are those of the authors and not necessarily those of Financial Engines.
Date Posted: 23 August 2019