We empirically analyze surrender behavior for variable annuity contracts using Japanese individual policy data. For traditional life insurance products, surrender behavior is typically explained by the interest rate and the emergency fund hypotheses. For variable annuities, the interest rate hypothesis is not directly applicable. For these products, we expect the value of the financial options and guarantees provided to the policyholder to drive surrender behavior. We define this expectation as the "moneyness hypothesis." The statistical analysis confirms our moneyness hypothesis: the value of the embedded financial options and guarantees has the largest explanatory power for the surrender rate. The extent to which this finding holds depends on the single premium paid, which we consider a proxy for the policyholder's financial literacy. Moreover, our data set weakly supports the emergency fund hypothesis for the case of variable annuities.
In this paper we analyze if multiple reference point theories can explain the relatively high attractiveness of annuities containing a capital guarantee. Therefore, we conducted a laboratory experiment where participants were confronted with an experimental annuitization decision from a mental accounting perspective. Previous research has shown that combining mental accounting and prospect theory can explain why annuities containing a guarantee are preferred to standard annuities, but this approach suffers from the shortcoming that from this perspective people would not annuitize their assets at all, but rather invest the money in a risk-free alternative. Recent research has extended prospect theory by additional reference points, in particular goals and thereby found a "cushion effect". When all possible outcomes of two options are above a certain goal, this goal serves as a cushion against negative emotions like disappointment and regret. Hence, individuals have a higher propensity to choose the risky option over the risk-free alternative with the same expected value. In our experiment, we find that individuals are more willing to purchase an annuity if it contains a capital guarantee. Moreover, we find evidence that individuals using this guarantee as a cushion were even more willing to choose the annuity. Hence, the "cushion effect" can partially explain the high demand for capital guarantee features in annuity contracts.2
We conducted an experiment in which participants were confronted with an experimental annuitization decision. Previous research has argued in favor of the hypothesis that a combination of mental accounting and prospect theory can explain why annuities containing a capital guarantee are preferred to standard annuities. However, from this perspective people would not annuitize their assets at all, but rather invest the money in a risk‐free alternative. Recent research has also suggested a “cushion effect.” When all possible outcomes of two options are above a certain goal, this goal serves as a cushion in case of unfavorable outcomes. Hence, individuals might have a higher propensity to exhibit risk‐seeking behavior. We find that individuals were indeed more willing to choose the annuity option if it contained a capital guarantee and that individuals using this guarantee as a cushion were even more willing to choose the annuity. Thus, the cushion effect can partially explain the high demand for guarantee features in annuity contracts.
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