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Optimal Gradual Annuitization: Quantifying the Costs of Switching to Annuities

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Author Info
Wolfram Horneff ()
Raimond Maurer ()
Michael Stamos ()
Abstract

We compute the optimal dynamic annuitization and asset allocation policy for a retiree with Epstein/Zin preferences, uncertain investment horizon, potential bequest motives, and pre-existing pension income. In our setting the retiree can decide each year how much he consumes and how much he invests in stocks, bonds, and life annuities, while the prior literature mostly considered restricted so-called deterministic or stochastic switching strategies. We show that postponing the annuity purchase is no longer optimal in the gradual annuitization case since investors are able to attain the optimal mix between liquid assets (stocks and bonds) and illiquid life-annuities each year. In order to assess potential utility losses, we benchmark various restricted annuitization strategies against the unrestricted gradual annuitization strategy.

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Paper provided by Department of Finance, Goethe University Frankfurt am Main in its series Working Paper Series: Finance and Accounting with number 174.

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Date of creation: 2008
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Handle: RePEc:fra:franaf:174

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Find related papers by JEL classification:
D91 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Consumer Choice; Life Cycle Models and Saving
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies
H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions
J26 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Retirement; Retirement Policies

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Olivia S. Mitchell et al., 1999. "New Evidence on the Money's Worth of Individual Annuities," American Economic Review, American Economic Association, vol. 89(5), pages 1299-1318, December. [Downloadable!] (restricted)
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  2. Bernheim, B Douglas, 1991. "How Strong Are Bequest Motives? Evidence Based on Estimates of the Demand for Life Insurance and Annuities," Journal of Political Economy, University of Chicago Press, vol. 99(5), pages 899-927, October. [Downloadable!] (restricted)
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  3. Blake, David & Cairns, Andrew J. G. & Dowd, Kevin, 2003. "Pensionmetrics 2: stochastic pension plan design during the distribution phase," Insurance: Mathematics and Economics, Elsevier, vol. 33(1), pages 29-47, August. [Downloadable!] (restricted)
  4. Wolfram Horneff & Raimond Maurer & Michael Stamos, 2006. "Life-Cycle Asset Allocation with Annuity Markets: Is Longevity Insurance a Good Deal?," Working Papers wp146, University of Michigan, Michigan Retirement Research Center. [Downloadable!]
  5. Richard, Scott F., 1975. "Optimal consumption, portfolio and life insurance rules for an uncertain lived individual in a continuous time model," Journal of Financial Economics, Elsevier, vol. 2(2), pages 187-203, June. [Downloadable!] (restricted)
  6. R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers 58, Massachusetts Institute of Technology (MIT), Department of Economics.
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  7. Kingston, Geoffrey & Thorp, Susan, 2005. "Annuitization and asset allocation with HARA utility," Journal of Pension Economics and Finance, Cambridge University Press, vol. 4(03), pages 225-248, November. [Downloadable!]
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  8. Thomas Davidoff & Jeffrey R. Brown & Peter A. Diamond, 2005. "Annuities and Individual Welfare," American Economic Review, American Economic Association, vol. 95(5), pages 1573-1590, December. [Downloadable!]
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Thomas Post, 2009. "Individual Welfare Gains from Deferred Life-Annuities under Stochastic Lee-Carter Mortality," SFB 649 Discussion Papers SFB649DP2009-022, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany. [Downloadable!]
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