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We examine the drivers of variable annuity sales and the impact of a proposed regulatory change. Variable annuities are popular retirement products with over $2 trillion in assets in the United States. Insurers typically pay brokers a commission for selling variable annuities that ranges from 0% to over 10% of investors' premium payments. Brokers earn higher commissions for selling inferior annuities, in terms of higher expenses and more ex-post complaints. Our results indicate that variable annuity sales are roughly six times more sensitive to brokers' financial interests than investors'. To help limit conflicts of interest, the Department of Labor proposed a rule in 2016 that would hold brokers to a fiduciary standard when dealing with retirement accounts. We find that after the proposed fiduciary rule, the sales of high-expense variable annuities fell by 52% as sales became more sensitive to expenses and insurers increased the relative availability of low-expense products. Based on our structural model estimates, investor welfare improved as a result of the fiduciary rule under conservative assumptions.

This study examines the impact of the adoption automatic enrollment provisions by the state of South Dakota for its supplemental retirement saving plan (SRP). In South Dakota, state and local government employees, including teachers, are also covered by a defined benefit pension plan and by Social Security. Thus, career public employees in South Dakota can expect a life time annuity from these two programs of around 75 percent of their final salary. Prior to the introduction of automatic enrollment, the proportion of newly hired employees who were contributing to the SRP was less than three percent in their first year of employment. After the introduction of automatic enrollment, over 90 percent of newly hired workers who were auto enrolled were participating in the plan. Significant differences compared to earlier studies of auto enrollment include: we are examining public employees who are also covered by a defined benefit retirement plan, prior to the introduction of auto enroll participation were extremely low, and these is no employer match to employee contributions to the SRP. Thus, the key question is whether auto enrollment has the same powerful impact on contributions to a retirement saving plan under these conditions.

Retirement policy has indirect effects on its beneficiaries, through the “crowd-out” or “crowd-in” of insurance markets. We study how retirement policy in Chile, which limits the drawdown of retirement assets but otherwise does not provide or require fixed income in retirement, results in more than 60% of eligible retirees purchasing private annuities at low prices. We estimate a demand model to show that replacing this voluntary policy with partial mandatory annuitization and removing limits on drawdowns causes the private annuity market to partially unravel. Under our model, this reform leads to a welfare increase equivalent to US$4,000 of additional pension savings on average, but welfare effects are heterogenous and many retirees would be harmed due to the higher prices of private annuities. Our results highlight the importance of considering the impact of policy reforms on the equilibria of related markets.

This study examines the impact of the adoption of automatic enrollment provisions by schools and universities in the state of South Dakota for its supplemental retirement saving plan (SRP). In South Dakota, educational personnel are also covered by a defined benefit pension plan and by Social Security. Thus, career public employees in South Dakota can expect a life time annuity from these two programs of around 75 percent of their final salary. Prior to the introduction of automatic enrollment, the proportion of newly hired educators who were contributing to the SRP was less than two percent in their first year of employment. After the introduction of automatic enrollment, over 90 percent of newly hired workers who were auto enrolled were participating in the plan. Thus, auto enrollment is shown to have the same powerful impact on contributions to a retirement saving plan for educational employees even when they also can expect life annuities from a defined benefit pension plan.

This study examines the distribution options of 85 large public retirement plans covering general state employees, teachers, and local government employees. The interest rates used to price annuities vary considerably across the plans. As a result, retirees with the same monthly benefit if a single life benefit is chosen will have substantially different monthly benefits if they select a joint and survivor annuity. We examine the impact of variation in the pricing of annuity options using both cross-plan differences in interest rates and the change in the choice of annuity options in one plan after the price of options changes due to new assumed interest rates and mortality rates.

This paper examines two behavioral factors that diminish people’s ability to value a lifetime income stream or annuity, drawing on a survey of about 4,000 adults in a U.S. nationally representative sample. By experimentally varying the degree of complexity, we provide the first causal evidence that increasing the complexity of the annuity choice reduces respondents’ ability to value the annuity, measured by the difference between the sell and buy values people assign to the annuity. We also find that people’s ability to value an annuity increases when we experimentally induce them to think jointly about the annuitization decision as well as how quickly or slowly to spend down assets in retirement. Accordingly, we conclude that narrow choice bracketing is an impediment to annuitization, yet this impediment can be mitigated with a relatively straightforward intervention.

We designed and fielded an experimental module in the 2014 HRS which seeks to measure older persons' willingness to voluntarily defer claiming of Social Security benefits. In addition we evaluate the stated willingness of older individuals to work longer, depending on the Social Security incentives offered to delay claiming their benefits. Our project extends previous work by analyzing the results from our HRS module and comparing findings from other data sources, which included very much smaller samples of older persons. We show that half of the respondents would delay claiming if no work requirement were in place under the status quo, and only slightly fewer, 46 percent, with a work requirement. We also asked respondents how large a lump sum they would need with or without a work requirement. In the former case, the average amount needed to induce delayed claiming was about $60,400, while when part-time work was required, the average was $66,700. This implies a low utility value of leisure foregone of only $6,300, or about 10 percent of older households' income.

This paper investigates whether exchanging the Social Security delayed retirement credit, currently paid as an increase in lifetime annuity benefits, for a lump sum would induce later claiming and additional work. We show that people would voluntarily claim about half a year later if the lump sum were paid for claiming any time after the Early Retirement Age, and about two-thirds of a year later if the lump sum were paid only for those claiming after their Full Retirement Age. Overall, people will work one-third to one-half of the additional months, compared to the status quo. Those who would currently claim at the youngest ages are likely to be most responsive to the offer of a lump sum benefit.

The conventional wisdom dating back to Yaari (1965) is that households without a bequest motive should fully annuitize their investments. Numerous market frictions do not break this sharp result. We modify the Yaari framework by allowing a household's mortality risk itself to be stochastic. Annuities still help to hedge longevity risk, but they are now subject to valuation risk. Valuation risk is a powerful gateway mechanism for numerous frictions to reduce annuity demand, even without ad hoc "liquidity constraints." We find that most households should not annuitize any wealth. The optimal level of aggregate net annuity holdings is likely even negative.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

This paper documents consumers’ difficulty valuing life annuities. Using a purpose-built experiment in the American Life Panel, we show that the prices at which people are willing to buy annuities are substantially below the prices at which they are willing to sell them. We also find that buy values are negatively correlated with sell values and that the sell–buy valuation spread is negatively correlated with cognition. This spread is larger for those with less education, weaker numerical abilities, and lower levels of financial literacy. Our evidence contributes to the emerging literature on heterogeneity in financial decision-making abilities, particularly regarding retirement payouts. (JEL: D14, D91, G11, H55)

Social Security benefits are currently provided as a lifelong benefit stream, though some workers would be willing to trade a portion of their annuity streams in exchange for a lump sum amount. This paper explores whether allowing people to receive a lump sum as a payment for delayed retirement rather than as an addition to their lifetime Social Security benefits might induce them to work longer. We model the factors that influence how people trade off a Social Security stream for a lump sum, and we also examine the consequences of such tradeoffs for work, retirement, and life cycle wellbeing. Our base case indicates that workers given the chance to receive their delayed retirement credit as a lump sum payment would boost their average retirement age by l.5-2 years. This will interest policymakers seeking to reform the Social Security system without raising costs or cutting benefits, while enhancing the incentives to delay retirement.

This paper discusses the role of annuities in retirement planning. It begins by explaining the basic theory underlying the individual welfare gains available from annuitizing resources in retirement. It then contrasts these findings with the empirical findings that so few consumers behave in a manner that is consistent with them placing a high value on annuities. After reviewing the strengths and weaknesses of the large literature that seeks to reconcile these findings through richer extensions of the basic model, this paper turns to a somewhat more speculative discussion of potential behavioral stories that may be limiting demand. Overall, the paper argues that while further extensions to the rational consumer model of annuity demand are useful for helping to clarify under what conditions annuitization is welfare-enhancing, at least part of the answer to why consumers are so reluctant to annuitize will likely be found through a more rigorous study of the various psychological biases that individuals bring to the annuity decision.

This paper evaluates the effects of population aging and fiscal policies on national saving in Korean situation. For the prediction of the national savings rate of Korea for the next several decades, we employ a life-cycle model, which incorporates the generational accounting approach needed to assess the distribution of fiscal burden across generations. We found that the rapid population aging and long-term budgetary imbalance will substantially lower the national savings rate in Korea. A sensitivity analysis based on an alternative model, an altruistic family model, shows that these predictions are robust to the specification of altruism among generations. In addition, the estimation results of consumption functions with respect to various kinds of wealth suggest that the annuitization of wealth due to maturing of public pensions and introduction of reverse annuity mortgage is likely to further decrease the savings rate in the future.

The tontine, which is an interesting mixture of group annuity, group life insurance, and lottery, has a peculiar place in economic history. In the seventeenth and eighteenth centuries it played a major role in raising funds to finance public goods in Europe, but today it is rarely encountered outside of murder mysteries. This study provides a formal model of individual contribution decisions under a tontine mechanism. We analyze the performance of tontines and compare them to another popular fundraising scheme used today by both government and charitable fundraisers: lotteries. Our major theoretical results are that (i) the optimal tontine for agents with identical valuations of the public good consists of all agents receiving a fixed "prize" amount in the first period equal to a percentage of their total contribution, (ii) contribution levels in the optimal tontine are identical to those of risk-neutral agents in an equivalently valued single prize lottery, (iii) contribution levels for the optimal tontine are independent of risk-aversion, and thereby outperform lotteries when agents are risk-averse, (iv) if agents are sufficiently asymmetric in their valuation of the public good, equilibrium contribution levels are larger under tontines than any lottery. In particular, one can obtain full participation in the tontine mechanism compared to only partial participation in a lottery. These insights highlight that the tontine institution can be a useful tool for fundraisers in the future.

This paper explores the extent to which retirees can and do insure themselves against longevity risk in private pension plans. We first review the theoretical and empirical results on the value of annuities, and discuss reasons why households may choose not to further insure themselves against longevity risk. We then analyze current trends in the private pension market, and find that the shift from defined benefit plans to defined contribution plans is likely to reduce annuitization rates among future retirees. This is driven primarily by the fact that the majority of DC plans, such as 401(k) plans, do not even offer participants a life annuity option at retirement. Thus, individuals who wish to annuitize generally must do so in the individual market where payouts are lower due to a healthier mortality pool. Hence, we can forecast that in the coming decades, absent institutional and regulatory changes, overall annuitization rates may fall and households may be increasingly exposed to the risk of outliving their financial resources, while the currently small private individual annuity market may witness significant growth. Finally, we discuss several policy options designed to increase annuitization of retirement resources.

In this paper we derive and compare the value of life annuity products in an international context. Our specific goal is to assess the money's worth and adverse selection impact of annuities in two countries Singapore and Australia that have mandatory DC-type retirement plans. This similarity in plan type is offset by differences in the two countries' national retirement policies. Our comparison therefore exploits the natural experiment in annuity pricing and purchase behaviour under alternative retirement regimes. The results show that after controlling on administrative loadings, there appear to be important differences in measured adverse selection across countries. Specifically, selection appears to be far stronger in the presence of a generous public benefit scheme that provides a first line of defence against the risk of old-age poverty.

In this paper, we investigate the importance of adverse selection in insurance markets. We use a unique data set, consisting of all annuity policies sold by a large U.K. insurance company since the early 1980s, to analyze mortality differences among individuals who purchased different types of policies. We find systematic relationships between ex-post mortality and annuity policy characteristics, such as whether the annuity will make payments to the estate in the event of an untimely death and whether the payments from the annuity rise over time. These mortality patterns are consistent with the presence of asymmetric information in the annuity market. We find no evidence of substantive mortality differences, however, across annuities of different size, even though models of insurance market equilibrium with asymmetric information would predict such differences. We also find that the pricing of various features of annuity contracts is consistent with the self-selection patterns we find in mortality rates. Our results therefore suggest that selection may occur across many specific features of insurance contracts and that the absence of selection on one contract dimension does not preclude its presence on others. This highlights the importance of considering the detailed features of insurance contracts when testing theoretical models of asymmetric information.

As growing numbers of retirees reach retirement age with substantial balances in self-directed retirement plans, annuities are likely to become increasingly important instruments for drawing down retirement savings. This study explores recent trends in the pricing of single-premium annuity products in the United States. Virtually all of the annuity products currently available in the United States offer fixed nominal payouts, rather than an inflation-linked payout stream. After describing the money's worth' of the various types of nominal annuity products, this study considers the extent to which existing U.S. private annuity markets provide retirees with inflation-protected retirement income flows. Although there is effectively no market yet for inflation-indexed annuities in the United States, such products are available in other countries. The paper concludes by summarizing recent data on the pricing of both nominal and inflation-linked annuities in the United Kingdom and several other nations.

This paper examines the extent of redistribution that would occur under various annuity and bequest options as part of an individual accounts retirement program. I first estimate mortality differentials by gender, race, ethnicity and level of education using the National Longitudinal Mortality Study and document substantial differences. I then use these estimates to examine the “expected transfers” that would take place between socioeconomic groups under different assumptions about the structure of an annuity program. Using an expected present discounted value or “money’s worth” calculation as the basis for comparison, I find that the size of transfers in an individual accounts program is highly sensitive to the benefit structure. For example, mandating a single-life, real annuity can result in expected transfers of as high as 20% of the account balance, often from economically disadvantaged groups toward groups that are better off. These transfers can be substantially reduced through the use of joint life annuities, survivor provisions and bequest options. For example, the largest expected negative transfer under a joint and full survivor annuity with a fully valued 20-year guarantee option is only 2% of the account balance. However, efforts to reduce the extent of redistribution generally do so at the cost of significantly lower annuity benefits paid to the individuals who contribute to the system.

This paper presents new evidence on the importance of adverse selection in individual annuity markets. It focuses on the individual annuity market in the United Kingdom, which provides an excellent empirical setting for studying selection effects. In addition to a voluntary annuity market, the U.K. also has a compulsory annuity market in which individuals in some types of retirement plans are effectively required to purchase retirement annuities. Two empirical regularities support standard models of adverse selection. First, annuitants as a group are longer-lived than randomly selected individuals in the population at large. The expected present value of the annuity payout stream from a typical voluntary annuity is thirteen percent higher for a typical 65-year-old male voluntary annuitant than for a typical 65-year-old male in the U.K. population. This is simply the result of differential mortality between the annuitant population and the population at large. Selection effects are more pronounced in the voluntary than in the compulsory annuity market, but even compulsory annuitants are not a random sample from the U.K. population. In the compulsory annuity market, the cost of adverse selection is between one third and one half of that in the voluntary annuity market. Second, annuitants select across different types of annuity products with different payout profiles, even within the compulsory market. The expected present values of payouts from inflation-indexed annuities and from nominal escalating annuities are lower than those from nominal annuities. This is consistent with longer-lived individuals choosing annuity products with greater payouts in the distant future. We find some puzzling evidence, however, in the relative pricing of nominal escalating annuities and inflation-indexed annuities. In addition to providing evidence on adverse selection, the U.K. annuity market can also be used to study how the price of an insurance product is related to the quantity of insurance purchased. Prices per annuity unit are lower for larger annuity policies than for smaller policies. Some theoretical models of insurance demand, which suggest that poorer risks should purchase more insurance and do not consider the fixed costs of issuing annuity or insurance policies, are inconsistent with this result.

This paper summarizes the development of private annuity markets in the United States. Annuities constituted a small share of the U.S. insurance market until the 1930s, when two developments contributed to their growth. First, concerns about the stability of the financial system drove investors to products offered by insurance companies, which were perceived to be stable institutions. Flexible payment deferred annuities, which permit investors to save and accumulate assets as well as draw down principal, grew rapidly in this period. Second, the group annuity market for corporate pension plans began to develop in the 1930s. The group annuity market grew more rapidly than the individual annuity market for several decades after World War II. The most recent development in the annuity marketplace has been the rapid expansion of variable annuities. These annuity products combine the investment features of mutual funds with the tax deferral available for life insurance products. Variable annuity premium payments increased by a factor of five in the most recent five years for which data are available.

This paper analyzes the savings and health care impacts of mortality contingent claims, defined here as income measures, such as annuities and life-insurance, under which earned income is contingent on the length of one's life. The postwar increase in mandatory annuity and life-insurance programs, as well as the rapid increase in life-expectancy, motivates a better understanding of the effects that mortality contingent claims have on resources devoted to life-extension. We analyze the incentives that such claims imply for life-extension when resources may affect mortality endogenously and argue that these incentives dramatically alter the standard conclusions obtained when mortality is treated exogenously.

This paper examines the tilt and risk-return characteristics of real retirement incomes provided by variable annuities tied to bills, long-term bonds, stocks and a mixed portfolio which combines all three. The analysis emphasizes the riskiness of the real value of benefits provided by conventional nominal annuities. The Rockefeller Foundation Plan, together with the "ad hoc" cost-of-living adjustments made by many large firms, are interpreted as representative market responses to increased inflation uncertainty. The paper examines the annuity designs implicit in these innovations, and shows them to be variants of the standard variable annuity.

Families can self-insure against uncertain dates of death through implicit or explicit agreements with respect to consumption and interfamily transfers. Interfamily transfers need have nothing to do with altruistic feelings; they may simply reflect risk-sharing behavior of completely selfish family members. Although family annuity markets are incomplete, even small families can substitute by more than 70 percent for perfect market annuities. Given adverse selection and transaction costs, family risk pooling may be preferred to public market annuities. In the absence of public annuities, these risk-sharing arrangements provide powerful incentives for marriage and family formation.

This paper shows that the optimal relation between social security benefits and retiree age depends on balancing the advantage of providing an otherwise unavailable actuarially fair annuity against the lower rate of return earned in a pay-as-you-go social security system. The ability of compulsory social security programs to provide an actuarially fair annuity implies that benefits should increase with age while the lower return on social security contributions than on private saving implies that a larger fraction of total benefits should be paid during the early years of retirement. In an economy that contains a mixture of rational life cycle savers and completely myopic individuals who do no saving, it is optimal for benefits to decline during the earlier part of the retirement period and then to begin rising. Numerical calculations based on actual macroeconomic parameters and representative survival probabilities suggest that the optimal age for minimum benefits occurs before age 75.

In this paper, we argue that actuarial valuation of annuity benefit streams is theoretically inconsistent with the assumption of pure lifecycle motives. Instead, we show that the simple discounted value of future benefits (ignoring the possibility of death) is often a good approximation to the relevant concept of value. This observation motivates a re-examination of existing empirical evidence concerning the effects of Social Security on personal savings, retirement, and the distribution of wealth, as well as the proper computation of age-wealth profiles. The conceptual points raised here are also relevant for evaluating the relative merits of wage and consumption taxes. In each case,we argue that the use of simple, rather than actuarial discounting of survival-contingent income streams dramatically alters the conclusions of previous studies.

This article examines how the availability of annuities affects savings and inequality in economies in which neither private nor public pensions initially exist. The absence of widespread market or government annuity insurance is clearly descriptive of many less developed countries in the world today; it was also a characteristic of virtually all countries prior to World War II. The paper compares economies with perfect insurance with economies in which completely selfish parents and children pool longevity risk to their mutual advantage. The analysis of the latter economies takes into account the infinite sequence of risk sharing bargains of successive parents with their children. Such bargains affect current risk sharing between parents and child because they determine the welfare of current children when they become parents. Calculations based on the CBS utility function indicate that perfecting annuity insurance can significantly reduce national savings. Indeed, the insurance aspects of government pensions are potentially as important as underfunding government pensions in reducing national savings.

If annuities such as Social Security are not chosen freely, the consumption path typically cannot be determined independently of the path of annuities. This constraint reduces the value of the annuity from the point of view of the annuitant. I measure the value of the annuity by the marginal rate of substitution (MRS), the amount of bequeathable wealth that will substitute for a dollar of annuity wealth. In the analytical section of the paper, I show that the MRS increases as bequeathable wealth increases; in that sense the wealthy benefit more from Social Security than the poor. In the empirical section, I estimate the MRS for a sample of retired single elderly. The MRS varies considerably from individual to individual because of differences in the mix of bequeathable wealth and annuities. For the parameter values that best fit the data, a substantial fraction of the sample has more Social Security than it would like in that it would be willing to trade, at the margin, a claim to Social Security for an increase in bequeathable wealth.

This paper suggests that adverse selection problems in competitive annuity markets can generate quantity-constrained equilibria in which some agents, whose length of lifetime is uncertain, find it advantageous to accumulate capital privately. This occurs despite the higher rates of return on annuities. The welfare properties of these allocations are analyzed. It is shown that the level of capital accumulation is excessive in a Paretian sense. Policies that eliminate this inefficiency are discussed. Copyright 1987 by University of Chicago Press.

This paper is organized as follows: The first part of the paper introduces the topic. In the next part, we explore the inadequacies of conventional and equity-based variable annuities in an inflationary environment by contrasting them with a hypothetical PPA. We then try to assess the suitability of money market instruments hedged with commodity futures as the asset base for PPA's, and consider the possibility of having financial institutions offer them to the public. The major conclusion of the paper is that private pension plans could offer retiring employees a choice between a conventional money-fixed annuity or a PPA, both of which would cost theemployer the same amount of money to fund, although this option would require the PPA benefitlevel in the first few years of retirement to be lower than that of the conventional annuity.