Portfolio Choice in Retirement: Health Risk and the Demand for Annuities, Housing, and Risky Assets

Abstract

In a life-cycle model, a retiree faces stochastic health depreciation and chooses consumption, health expenditure, and the allocation of wealth between bonds, stocks, and housing. The model explains key facts about asset allocation and health expenditure across health status and age. The portfolio share in stocks is low overall and is positively related to health, especially for younger retirees. The portfolio share in housing is negatively related to health for younger retirees and falls significantly in age. Finally, out-of-pocket health expenditure as a share of income is negatively related to health and rises in age.

Social security and the rise in health spending

“…In terms of modeling, this paper is closely related to a recent macroeconomic literature that studies a quantitative macroeconomic model with endogenous health (Suen, 2006;Hall and Jones, 2007;Yogo, 2007;Jung and Tran, 2008;Halliday et al, 2009, among others).…”

Optimizing the equity-bond-annuity portfolio in retirement: The impact of uncertain health expenses

“…Dus et al (2005), Horneff et al (2006a,b, 2007, 2008, 2009 examine various investment portfolios and wealth withdrawal strategies in a life-cycle framework, quantify welfare gains with the addition of fixed or variable annuities, and generally show that a well designed equity-bond-annuity portfolio will offer retirees the chance to capture an equity premium when younger and exploit longevity insurance and mortality credit of annuities in later life. These studies, however, do not address the impact of uninsured health expenses on asset allocation and annuitization choices, which are considered specifically in our analysis.…”

“…Uncertain health expenses, when occurring early in retirement, call for more liquidity holdings and less (illiquid) annuities, but will make annuities better financial instruments to hedge against such expenses if they occur late in life. Yogo (2008) models health as a durable consumption good and health expenditures as endogenous investments in health, rather than treating them as exogenous negative income shocks. The author finds that the need for precautionary savings essentially disappears because the retiree can invest directly in health and accumulate health capital, in place of accumulating liquid assets.…”

“…In their view, health spending increases utility both ''by increasing the quantity of life through a mortality reduction and by increasing the quality of life (page 49).' ' Yogo (2008) models health expenditures as endogenous investments in health. Brown and Finkelstein (2008) state that ''we do not consider it reasonable to assume that the individual is receiving no consumption value from institutional care .…”

The impact of the correlation between health expenditure and survival probability on the demand for insurance

“…For the literature on annuitizatoin, see Yaari (1965), Kotlikoff and Spivak (1981), Sinclair and Smetters (2004), Yogo (2009), Lockwood (2011), Pashchenko (2013 …”