What Matters for Annuity Demand: Objective Life Expectancy or Subjective Survival Pessimism?

Karolos Arapakis and Gal Wettstein

Issues in Brief from Center for Retirement Research

Abstract: Since 1965, academics have argued that individuals should annuitize a large part of their wealth. However, for nearly as long, studies have documented that annuitization rates fall far short of what seem to be optimal levels. Researchers have proposed multiple explanations for this potentially sub-optimal outcome. This brief, based on a recent study, assesses the relative importance of two explanations of this outcome, called the annuity puzzle. The first explanation is that annuity prices are set to compensate insurers for the higher average life expectancy of those who voluntarily purchase annuities, thereby making the product less attractive to potential consumers. The second explanation is that individuals in their 50s and 60s subjectively underestimate their life expectancy, which makes them perceive annuities as less attractive. The discussion proceeds as follows. The first section provides a brief background. The second section describes the data and methodology. The third section presents the results: a one-year decrease in objective life expectancy is associated with a 0.20-percentage-point reduction in the chance of receiving income from a commercial annuity, which is nearly nine times larger than the association with an individual subjectively believing that he will live for one year less. The final section concludes that better understanding what drives annuitization is important for annuity providers and policymakers alike. If irrational subjective mortality pessimism were driving low annuitization rates, better informing the public about mortality rates could have reduced the problem. Given that objective life expectancy is the more important factor, a larger public role in the provision of annuities could be considered.

Pages: 5 pages
Date: 2023-01
New Economics Papers: this item is included in nep-age and nep-hea
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