Hostname: page-component-586b7cd67f-dlnhk Total loading time: 0 Render date: 2024-11-25T11:22:37.093Z Has data issue: false hasContentIssue false

The implication of the hyperbolic discount model for the annuitisation decisions

Published online by Cambridge University Press:  07 February 2019

Anran Chen*
Affiliation:
Faculty of Actuarial Science and Insurance, Cass Business School, City, University of London, 106 Bunhill Row, LondonEC1Y 8TZ, UK
Steven Haberman
Affiliation:
Faculty of Actuarial Science and Insurance, Cass Business School, City, University of London, 106 Bunhill Row, LondonEC1Y 8TZ, UK
Stephen Thomas
Affiliation:
Faculty of Finance, Cass Business School, City, University of London, 106 Bunhill Row, LondonEC1Y 8TZ, UK
*
*Corresponding author. Email: [email protected]

Abstract

The low demand for immediate annuities at retirement has been a long-standing puzzle. We show that a hyperbolic discount model can explain this behaviour and results in the attractiveness of long-term deferred annuities. With a set of benchmark assumptions, we find that retirees would be willing to pay a much higher price than the actuarial fair price for annuities with longer deferred periods. Moreover, if governments were to introduce a pre-commitment device which requires pensioners to make annuitisation decisions around 10 years before retirement, the take up rate of annuities could become higher.

Type
Article
Copyright
Copyright © Cambridge University Press 2019

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Abdellaoui, M, Attema, AE and Bleichrodt, H (2009) Intertemporal tradeoffs for gains and losses: an experimental measurement of discounted utility. The Economic Journal 120, 845866.CrossRefGoogle Scholar
ABI (2015) UK insurance and long term savings key facts 2015. Tech. rep., Association of British Insurers.Google Scholar
Agarwal, S, Driscoll, JC, Gabaix, X and Laibson, D (2009) The age of reason: financial decisions over the life-cycle with implications for regulation. Brookings Papers on Economic Activity 2009, 51101.CrossRefGoogle Scholar
Andersen, C and Skjodt, P (2008) Pension institutions and annuities in Denmark. Policy Research Working Paper WPS4437, The World Bank.CrossRefGoogle Scholar
Brown, JR and Poterba, JM (2000) Joint life annuities and annuity demand by married couples. Journal of Risk and Insurance 67, 527553.CrossRefGoogle Scholar
Brown, JR and Warshawsky, MJ (2001) Longevity-insured retirement distributions from pension plans: Market and regulatory issues. NBER Working Paper 8064, National bureau of economic research.CrossRefGoogle Scholar
Brown, JR, Kling, JR, Mullainathan, S and Wrobel, MV (2008) Why don't people insure late-life consumption? A framing explanation of the under-annuitization puzzle. American Economic Review 98, 304309.CrossRefGoogle Scholar
Brown, JR, Kapteyn, A, Luttmer, E and Mitchell, OS (2012) Do consumers know how to value annuities? Complexity as a barrier to annuitization. RAND Working paper, 45.Google Scholar
Butler, M, Peijnenburg, K and Staubli, S (2017) How much do means-tested benefits reduce the demand for annuities? Journal of Pension Economics and Finance 16, 419449.CrossRefGoogle Scholar
Cannon, E and Tonks, I (2008) Annuity Markets. Oxford: Oxford University Press.CrossRefGoogle Scholar
Cannon, E and Tonks, I (2011) Annuity markets: Welfare, money's worth and policy implications. Netspar Panel Papers 24, Netspar.Google Scholar
Chen, A, Haberman, S and Thomas, S (2019) Cumulative prospect theory and deferred annuities. Review of Behavioral Finance Forthcoming.CrossRefGoogle Scholar
Continuous mortality investigation (2013) Proposed ‘S2’ tables. Research and resources, Institute and Faculty of Actuaries.Google Scholar
Denuit, M, Haberman, S and Renshaw, AE (2015) Longevity-contingent deferred life annuities. Journal of Pension Economics and Finance 14, 315327.CrossRefGoogle Scholar
Dicenzo, J, Shu, SB, Hadar, L and Rieth, C (2011) Can annuity purchase intentions be influenced? Society of Actuaries Research Paper. Available at https://www.soa.org/Files/Research/Projects/research-can-annuity.pdfGoogle Scholar
Dushi, I and Webb, A (2004) Household annuitization decisions: simulations and empirical analyses. Journal of Pension Economics and Finance 3, 109143.CrossRefGoogle Scholar
Frederick, S, Loewenstein, G and O'donoghue, T (2002) Time discounting and time preference: a critical review. Journal of Economic Literature 40, 351401.CrossRefGoogle Scholar
Friedman, BM and Warshawsky, MJ (1990) The cost of annuities: implications for saving behavior and bequests. The Quarterly Journal of Economics 105, 135154.CrossRefGoogle Scholar
Gavranovic, N (2011) Optimal Asset Allocation and Annuitisation in Defined Contribution Pension Scheme. Ph.D. thesis, Cass Business School, City University London.Google Scholar
Gong, G and Webb, A (2010) Evaluating the advanced life deferred annuity – an annuity people might actually buy. Insurance: Mathematics and Economics 46, 210221.Google Scholar
HM TREASURY (2014) Freedom and choice in pensions: government response to the consultation. Government UK.Google Scholar
Hu, W and Scott, JS (2007) Behavioral obstacles in the annuity market. Financial Analysts Journal 63, 7182.CrossRefGoogle Scholar
Laibson, D (1998) Life-cycle consumption and hyperbolic discount functions. European Economic Review 42, 861871.CrossRefGoogle Scholar
Laibson, D, Repetto, A and Tobacman, J (2003) Wealth accumulation, credit card borrowing, and consumption-income comovement. Tech. rep., Centro de Economía Aplicada, Universidad de Chile.Google Scholar
Lockwood, LM (2012) Bequest motives and the annuity puzzle. Review of Economic Dynamics 15, 226243.CrossRefGoogle ScholarPubMed
Loewenstein, G (1987) The Weighting of Waiting: Response Mode Effects in Intertemporal Choice. Chicago: Center for Decision Research, Graduate School of Business, University of Chicago.Google Scholar
Loewenstein, G and Prelec, D (1992) Anomalies in intertemporal choice: evidence and an interpretation. The Quarterly Journal of Economics 107, 573597.CrossRefGoogle Scholar
Milevsky, MA (2005) Real longevity insurance with a deductible: introduction to advanced-life delayed annuities (ALDA). North American Actuarial Journal 9, 109122.CrossRefGoogle Scholar
OECD (2016) OECD pensions Outlook 2016. Paris: OECD Publishing.Google Scholar
Redden, JP (2007) Hyperbolic discounting. In Baumeister RF and Vohs KD (eds), Encyclopedia of Social Psychology. Thousand Oaks, CA: SAGE Publications, pp. 450452.Google Scholar
Schreiber, P and Weber, M (2015) Time inconsistent preferences and the annuitisation decision. CEPR Discussion Paper.Google Scholar
Shu, SB, Robert, Z and Payne, J (2016) Consumer preferences for annuities attributes: beyond net present value. Journal of Marketing Research LIII, 240262.CrossRefGoogle Scholar
Sinclair, S and Smetters, KA (2004) Health Shocks and the Demand for Annuities. Washington, DC: Congressional Budget Office.Google Scholar
Thaler, R (1981) Some empirical evidence on dynamic inconsistency. Economic Letters 8, 201207.CrossRefGoogle Scholar
Tversky, A and Kahneman, D (1992) Advances in prospect theory: cumulative representation of uncertainty. Journal of Risk and Uncertainty 5, 297323.CrossRefGoogle Scholar
Vidal-Melia, C and Lejarraga-Garcia, A (2006) Demand for life annuities from married couples with a bequest motive. Journal of Pension Economics and Finance 5, 197229.CrossRefGoogle Scholar
Yaari, ME (1965) Uncertain lifetime, life insurance, and the theory of the consumer. The Review of Economic Studies 32, 137150.CrossRefGoogle Scholar