Accounting for non-annuitization

Abstract

Why don't people buy annuities? Several explanations have been provided by the previous literature: large fraction of preannuitized wealth in retirees' portfolios; adverse selection; bequest motives; and medical expense uncertainty. This paper uses a quantitative model to assess the importance of these impediments to annuitization and also studies three newer explanations: government safety net in terms of means-tested transfers; illiquidity of housing wealth; and restrictions on minimum amount of investment in annuities. This paper shows that quantitatively four explanations play a big role in reducing annuity demand: preannuitized wealth, minimum annuity purchase requirement, illiquidity of housing wealth, and bequest motives. The annuity purchase involves big upfront investment, especially if there is a minimum purchase restriction. This is binding for many, especially if housing is illiquid and part of wealth is preannuitized. While bequest motives significantly reduce the overall annuity demand, the model with a strong bequest motive cannot match the empirical fact that high-income people have the highest demand for annuities.

How much do means-tested benefits reduce the demand for annuities?

“…24 In all three schemes, individuals are eligible for the same supplemental income schemes (including less strict assets tests as in the Swiss case) in case their combined income falls short of the guaranteed income. As a final alternative we consider stricter asset tests to qualify for 23 Pashchenko (2010) tests the implications of means-tested benefits with more stringent asset tests (compared to our baseline case) on optimal annuity decisions. She uses $2,663 per year as a minimum income level and meanstested benefits are reduced dollar for dollar with income and assets, and finds that the participation level in the annuity market decreases for higher levels of the consumption floor.…”

“…Section 3 gives an overview of the Swiss pension system to which the model is calibrated and which serves as an 4 Pashchenko (2010) demonstrates that a minimum consumption floor (implying very stringent asset test rules) reduces the participation rate in voluntary annuity markets, particularly at the bottom of the income distribution. The guaranteed income in Pashchenko (2010) is very low at only $2,663 per year (an estimate taken from De Nardi et al (2010), which reflects a mixture of minimum income level and value placed on different nursing home arrangements.) A guaranteed income level of $2,663 is substantially smaller than the levels in countries with a similar GDP and some U.S. states (for example, it is $20,000 in Australia and $36,000 in Switzerland).…”

Health State Transitions and Longevity Effects on Retirees’ Optimal Annuitization

“…This conflicts with the observation that relatively few retirees annuitize a substantial portion of their wealth (the "annuity puzzle"). To explain this puzzle, recent literature has identified factors affecting annuity demand, including preannuitized wealth, such as social security and pension plans (Dushi and Webb, 2004), uncertain income (Scholz, Seshadri, and Khitatrakun, 2006), unfair annuity pricing (Mitchell et al, 1999), bequest motives (Kopczuk and Lupton, 2007;Lockwood, 2012), minimum support from government subsidies (Ameriks et al, 2011;Pashchenko, 2013), and illiquidity of assets (Pashchenko, 2013;Yogo, 2014).…”

Behavioral Household Finance

“…When they simulate their model, they find that optimal holdings of annuities are low and roughly match observed levels of annuitization, especially when they introduce additional realistic frictions. Pashchenko (2013) develops an elaborate model that includes many of the extensions described above as well as others in order to assess the relative importance of different classical explanations for the annuity puzzle. She finds that pre-existing annuitization from government pension programs, bequest motives, minimum purchase amounts for private-market annuities, and the illiquidity of housing wealth (which makes it costly to convert housing wealth into annuities) are key contributors to the low demand for annuities.…”