Solving the Puzzle within the Annuity Puzzle: Incorporating Irrevocability Aversion into Annuity Choice
By Spencer Look, Tao Guo & Yuanshan Cheng
Researchers have found that annuities provide substantial benefits to retirement investors. Income annuities, which require the purchaser to irrevocably exchange an insurance premium for future income, are typically considered the most efficient vehicle to generate lifetime income. However, the Life Insurance Marketing and Research Association (“LIMRA”) estimated that the actual sales of income annuities only accounted for 12% of income-focused annuity sales (LIMRA, 2022a). Most of the sales are attributable to deferred annuities with a guaranteed lifetime withdrawal benefit, which provide the purchaser ongoing access to the wealth in the product. This study builds upon a classic life cycle finance utility framework by introducing a discount factor penalty when the annuity is irrevocable. The magnitude of the penalty depends on the irrevocability aversion coefficient. We found that inclusion of this discount factor penalty can explain the distribution of actual annuity sales. Our framework can be used to inform annuity choice.
Source @SSRN
