JASON S. SCOTT, Financial Engines, Inc.
Email: jscott@financialengines.com
JOHN G. WATSON, Financial Engines, Inc.
Email: jwatson@financialengines.com
WEI-YIN HU, Financial Engines, Inc.
Email: whu@financialengines.com

The wide gulf between actual and predicted annuity demand has been well documented. However, a comparable gap exists between the current and ideal annuity market. In a world with costly and limited annuity products, we investigate what types of new annuity products could improve annuity market participation and increase individual welfare. We find that participation gains are most likely for new annuity products that focus on late-life payouts which offer a large price discount relative to their financial market analogues. For example, the marginal utility from the first dollar allocated to a late-life annuity can be several times that of an immediate annuity. Our welfare analysis indicates that an individual?s current assets suggest desirable new annuity products since annuities that lower the cost of the existing consumption plan necessarily improve welfare. Finally, we consider the implications for annuity demand if new annuity products ultimately complete the annuity market. Given access to a complete market, we find all individuals only purchase annuity contracts with a significant time gap between purchase and payout. At a minimum, enough time must pass between purchase and payout to build up a mortality discount sufficient to overcome the cost of creating the contract. Since most existing annuity products, such as immediate annuities, do not have this feature, few current annuity contract configurations are likely to survive significant product innovation. Taken together, our results indicate that there is ample opportunity for innovation to spur annuity demand and improve individual welfare.

WOLFRAM J. HORNEFF, Goethe University Frankfurt - Department of Finance
Email: horneff@finance.uni-frankfurt.de
RAIMOND MAURER, University of Frankfurt - Faculty of Business and Economics
Email: Rmaurer@wiwi.uni-frankfurt.de
OLIVIA S. MITCHELL, University of Pennsylvania - Insurance & Risk Management Department, National Bureau of Economic Research (NBER)
Email: mitchelo@wharton.upenn.edu
MICHAEL Z. STAMOS, Goethe University Frankfurt, Allianz Global Investors
Email: stamos@wiwi.uni-frankfurt.de

Many retirees hope to continue earning capital market rewards on their saving while avoiding outliving their funds during retirement. We model a dynamic utility maximizing investor who seeks to benefit from holding both equity and longevity insurance. She is free to adjust her portfolio allocation of her financial wealth as well as of the annuity over time, and she can purchase variable payout annuities any time and incrementally. In this setting, we show that the retiree will not fully annuitize even without bequests; rather, she will combine variable annuities with withdrawals from her liquid financial wealth so as to match her desired consumption profile. Optimal stock exposures decrease over time, both within the variable annuity and the withdrawal plan. Welfare gains from this strategy can amount to 40% of financial wealth, depending on risk parameters and other resources; additionally, many retirees will do almost as well as the fully optimized outcome if they hold variable annuities invested 60/40 in stocks/bonds.

PABLO ANTOLIN, Organisation for Economic Cooperation and Development, OECD
Email: PABLO.ANTOLIN@OECD.ORG

This paper reviews the impact of aging on private pensions, in particular on the payout phase, assesses the part that annuities can play in financing retirement, and examines the role of financial markets in facilitating the allocation on assets accumulated in defined contribution pension plans. A comprehensive set of recommendations for discussion is provided at the end of the paper.

DEBBIE HARRISON, City University London - Sir John Cass Business School
Email: debbie.harrison@virgin.net
ALISTAIR BYRNE, University of Edinburgh - Business School
Email: alistair.byrne@ed.ac.uk
DAVID P. BLAKE, City University London - Cass Business School - The Pensions Institute
Email: d.blake@city.ac.uk

"Annuities and Accessibility: How the industry can empower consumers to make rational choices" was published on Thursday 16 March 2006. The report calls on the Financial Services Authority, specialist annuity advisers, trustees, and employers to respond to key recommendations that could transform the way consumers in the mass market buy their lifetime annuities from insurance companies.

THOMAS DAVIDOFF, University of California, Berkeley - Haas School of Business
Email: davidoff@haas.berkeley.edu

Annuities, long-term care insurance (LTCI), and reverse mortgages appear to offer important consumption smoothing benefits to the elderly, yet private markets for these products are small. A prominent idea is to combine LTCI and annuities to alleviate both supply (selection) and demand (liquidity) problems in these markets. This article shows that if consumers typically liquidate home equity only in the event of illness or very old age, then LTCI and annuities become less attractive and may become substitutes rather than complements. The reason is that the marginal utility of wealth drops when an otherwise illiquid home is sold, an event correlated with the payouts of both annuities and LTCI. Simulations confirm that demand for LTCI and annuities is highly sensitive to the liquidity and magnitude of home equity.

PABLO ANTOLIN, Organisation for Economic Cooperation and Development, OECD
Email: PABLO.ANTOLIN@OECD.ORG
COLIN PUGH, affiliation not provided to SSRN
FIONA STEWART, Organization for Economic Co-Operation and Development (OECD)
Email: fiona.stewart@oecd.org

This paper focuses on describing the international practice on the various forms of retirement benefit payment currently allowed in countries throughout the world and the regulatory environment surrounding these different forms of benefit payment. The analysis suggests considerable variance between countries. Some countries only allow one form of retirement payment, while others allow several forms or even a combination of them. Examining country practices as regard the providers of benefit payments, suggest that lump-sums and programmed withdrawals are generally provided by pension funds; while, as regard life annuities, providers varied from insurance companies, to pension funds, financial intermediaries and a centralized annuity fund. The paper ends by examining the role of taxation where a choice between different types of benefit payments is allowed. Tax provision plays a key direct or indirect role in influencing payout options. Cross country evidence is varied but suggests that there is often an unequal tax treatment of the various forms of retirement payout options

ROBERT S. GAZZALE, Williams College - Department of Economics
Email: rgazzale@williams.edu
LINA WALKER, AARP-Public Policy Institute
Email: lwalker@aarp.org

We conduct a neutral-context laboratory experiment to systematically investigate the role of the hit-by-bus concern in explaining the annuitization puzzle: the low rate of retirement-asset annuitization relative to the predictions of standard models. We vary endowed asset (annuity vs. stock of wealth vs. no explicit endowment), and find a strong endowment effect. Furthermore, we find that the ordering of survival risks matters. Compared to a frame in which a single draw from a known distribution determines survival outcome, annuity choice is lower when subjects must sequentially survive early periods to reach periods in which the annuity dominates. We conclude with policy implications.