Explaining Low Annuity Demand: An Optimal Portfolio Application to Japan

Abstract

Using an optimising financial planning model in the tradition of Merton (1969, 1971), and Richard (1975 we explore how individuals should determine their life insurance and annuity choices, given uncertainty about investment returns and mortality. Both consumption and bequests appear as arguments in the individual's preference function. The model explicitly recognises the existence of social security in retirement, and of loadings on insurance premiums, due to administration costs in the life insurance and annuities markets. The model sheds light on the reasons for the thinness of voluntary life annuity markets worldwide. The relative importance of pre-existing annuitisation through social security, the role of bequests, and premium loadings are quantitatively assessed within a single optimising framework. Results are presented for a model specification calibrated to Japan.

Time inconsistent preferences and the annuitization decision

“…Other possible explanations are incomplete annuity markets (Davidoff et al, 2005) and the crowding out of private annuitization by the government (Mitchell and Moore, 1998;Dushi and Webb, 2004;Purcal and Piggott, 2008). Despite all the efforts to explain the annuity puzzle, the success of the studies and models described above is only moderate.…”

“…However, owning private pension insurance leads to the tendency to favor the annuity. One could expect that demand for annuities decreases because in this case the annuity could be crowded out by already existing private annuitization (see for the crowding out argument Mitchell and Moore, 1998; Dushi and Webb, 2004;Purcal and Piggott, 2008). Nevertheless, owning private pension insurance seems to proxy more for participants who have a general preference for insurance against longevity risk.…”

Demand for life annuities: a Brazilian perspective

“…The literature on annuity conversions is extensive (Dus, Maurer, & Mitchell, 2005;Inkmann, Lopes, & Michaelides, 2011;Milevsky & Young, 2002;Purcal & Piggott, 2008;Yaari, 1965) and usually attempts to explain the reasons behind the low level of conversion observed worldwide in the field of open complementary pensions. Most of the papers try to understand such a puzzle, since "numerous households would benefit by increasing the share of their retirement wealth that is annuitized" (Benartzi, Previtero, & Thaler, 2011).…”

“…In his study, the author concludes that the decision whether or not to convert accumulated savings into a lifetime annuity is affected by the desire to transfer wealth to descendants. A series of subsequent studies sought to measure this effect and results range from a strong influence (Bernheim, 1991;Purcal & Piggott, 2008), to a negligible influence (Horneff, Maurer, Mitchell, & Stamos, 2010;Melia & García, 2006). Milevsky and Young (2002) introduced a real options utility to identify the factors that encourage investors to delay the annuitization of their accumulated wealth.…”

“…The authors also highlight how the high costs charged by pension institutions create annuities offered at actuarially unfair prices and thus a negative effect on the conversion rate. Purcal and Piggott (2008) studied the reasons for the low demand for voluntary annuities in Japan and, as done in previous studies, modeled the problem using the theory of utility maximization for the individual throughout his life. Their main contribution to the literature on this subject was to demonstrate that the retirement pension granted by Japan's social security (which absorbs most of the demand for annuities) and the high fees charged by the companies selling these products were very important factors on deciding whether or not to annuitize.…”