The Annuity Puzzle and an Outline of Its Solution. Issue 4 (2nd October 2018)

• Record Type: Journal Article
• Authors: Ramsay, Colin M.; Oguledo, Victor I.
• Is Part Of: North American actuarial journal. Volume 22:Issue 4(2018)
• Page Start: 623
• Page End: 645
• Publication Date: 2018-10-02
• Subjects: Life insurance -- Research -- North America -- Periodicals; Actuarial science -- North America -- Periodicals; Web sites; Electronic journals; 368.010973
• DOI: 10.1080/10920277.2018.1470936
• Languages: English
• ISSNs: 2325-0453

Abstract

Abstract : In his seminal 1965 paper, Yaari showed that, assuming actuarially fair annuity prices, uncertain lifetimes, and no bequest motives, utility-maximizing retirees should annuitize all of their wealth on retirement. Nevertheless, the markets for individual immediate life annuities in the United States, the United Kingdom, and several other developed countries have been small relative to other financial investment outlets competing for retirement savings. Researchers have found this situation puzzling, hence the so-called "annuity puzzle." There are many possible explanations for the annuity puzzle, including "rational" explanations such as adverse selection, bequest motives, and incomplete markets; and "behaviorial" explanations, such as mental accounting, cumulative prospect theory, and mortality salience. We review the literature on the various plausible explanations given for the existence of the annuity puzzle, suggest ways of stimulating the demand for annuities, and suggest a few of the ingredients needed for further development of hybrid annuity products that may provide a solution to the puzzle.