Cognitive Constraints on Valuing Annuities

Brown, Jeffrey R.; Kapteyn, Arie; Luttmer, Erzo F. P.; Mitchell, Olivia S.

doi:10.2139/ssrn.2523596

Cited by 12 publications

(15 citation statements)

References 70 publications

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“…As individuals are being asked to exert more control over their own retirement accounts (e.g., 401(k)’s) and other household investments, this raises a concern about whether consumers are capable of making optimal investment and saving decisions. Further, the development of ever-more complex financial products makes it difficult for consumers to use these sensibly (Brown et al ., 2017). What we have shown is that participant awareness of higher net-return funds can be greatly enhanced when information on fees is simplified in terms of likely gains from selecting higher net return funds.…”

Section: Conclusion and Discussionmentioning

confidence: 99%

How financial literacy and impatience shape retirement wealth and investment behaviors

Hastings

Mitchell

2018

Journal of Pension Economics and Finance

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131

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Two competing explanations for why consumers have trouble with financial decisions are gaining momentum. One is that people are financially illiterate since they lack understanding of simple economic concepts and cannot carry out computations such as computing compound interest, which could cause them to make suboptimal financial decisions. A second is that impatience or present-bias might explain suboptimal financial decisions. That is, some people persistently choose immediate gratification instead of taking advantage of larger long-term payoffs. We use experimental evidence from Chile to explore how these factors appear related to poor financial decisions. Our results show that our measure of impatience is a strong predictor of wealth and investment in health. Financial literacy is also correlated with wealth though it appears to be a weaker predictor of sensitivity to framing in investment decisions. Policymakers interested in enhancing retirement well-being would do well to consider the importance of both factors.

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Section: Conclusion and Discussionmentioning

confidence: 99%

How financial literacy and impatience shape retirement wealth and investment behaviors

Hastings

Mitchell

2018

Journal of Pension Economics and Finance

Self Cite

131

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“…Using prospect theory (Kahneman and Tversky, 1979) and mental accounting (Thaler, 1985), annuities are shown to be systematically undervalued by retirees (Hu and Scott, 2007). Individuals of lower cognitive ability especially tend to make mistakes in valuing annuities (Brown et al, 2013). One line of research focuses on the use of so-called investment framing instead of consumption framing (Brown et al, 2008).…”

Section: Introductionmentioning

confidence: 99%

Framing and the annuitization decision – Experimental evidence from a Dutch pension fund

Bockweg

Ponds²,

Steenbeek

et al. 2017

Journal of Pension Economics and Finance

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We report the effects of framing and default settings in annuity demand after conducting a survey-based experiment with over 3,000 members of a Dutch occupational pension plan. The participants were asked to allocate their real projected pension accrual between a life annuity and a partial lump sum. In particular, we investigated the joint effects of consumption and investment frames and gain and loss frames. We present strong evidence for framing and default setting effects in annuity demand. We also find robust evidence of individual characteristics of influence annuity demand, highlighting the importance of heterogeneity among participants. Framing and default effects remain significant when we control for individual characteristics. We conclude Dutch plan members generally welcome the partial lump sum option over full annuitization. Framing and default settings are generally capable of predictively steering annuity demand. The precise effect framing may have also depends on the institutional environment, which predefines the perspective through which individuals filter annuities.

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“…Framing effects are also significant (although mediated by gender) in Agnew, Anderson, Gerlach, and Szykman's (2008) simulated retirement game in which individuals choose between annuities and selfmanaged investments. Most recently, Brown, Kapteyn, Luttmer, and Mitchell (2017) find experimental evidence for narrow bracketing, demonstrating that survey respondents encouraged to think about spending during retirement are more likely to properly value annuities. In our prior work, we have found that information displays that help individuals "do the math" on the cumulative value of annuity payouts can affect both overall interest in annuities and demand for particular annuity attributes (Shu, Zeithammer, & Payne, 2016; see also Kunreuther, Pauly, & McMorrow, 2013).…”

Section: Research On Annuity Choicementioning

confidence: 99%

“…Building on research on how trust, branding, company ratings, and perceived fairness all affect consumer choices, we measure perceived fairness of annuities as a product (Kahneman, Knetsch, & Thaler, 1986;Roth, 2007;Seligman & Schwartz, 1997). Response to annuity offerings may also be affected by individuals' financial knowledge and literacy, numeracy, and overall cognitive ability (Brown et al, 2017), so we also include a measure of numeracy (Fernandes, Lynch Jr, & Netemeyer, 2014;Frederick, 2005;Peters et al, 2006). We measure all of these psychological differences, along with a variety of demographical and financial variables, and analyze how they correlate with individual-level demand for annuities in a hypothetical decumulation scenario among consumers nearing retirement.…”

Section: Research On Annuity Choicementioning

confidence: 99%

The pivotal role of fairness: Which consumers like annuities?

2018

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Decumulation of wealth in retirement is a difficult task, requiring tradeoffs between longevity risks and immediate consumption needs. Economists have long argued that life annuities can be a valuable part of decumulation and that most retirees should annuitize, and yet actual market demand is quite low–the so‐called “annuity puzzle.” We analyze data from two studies to understand how measurable individual differences predict interest in annuities. In our data, a relatively high percentage of respondents dislike all annuities; demographic measures are not predictive of which individuals never choose annuities, and individual factors (such as beneficiaries) favored by economic models have small or even opposite effects. We find that the strongest individual differences predictive of liking of annuities are the respondent's perception of product fairness. We discuss implications of our findings for financial planners hoping to help customers with their decumulation challenges.

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Cognitive Constraints on Valuing Annuities

Cited by 12 publications

References 70 publications

How financial literacy and impatience shape retirement wealth and investment behaviors

How financial literacy and impatience shape retirement wealth and investment behaviors

Framing and the annuitization decision – Experimental evidence from a Dutch pension fund

The pivotal role of fairness: Which consumers like annuities?

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