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Are annuities value for money?: who can afford them?


  • Lopes, Paula


This paper solves an empirically parameterized model of households’ optimal demand for nominal and inflation indexed annuities. The model incorporates mortality, inflation, and real interest rate risk. The model draws some interesting predictions. First, the welfare calculations on the access to annuities markets show that nominal annuities are welfare improving even when sold at the empirically parameterized cost, which is above fair value. Real annuities are welfare improving over nominal annuities when sold at a fair price, but when we incorporate the empirically parameterized annuity premium the gains become negative at all wealth levels. Second, the simulation of the model for the British population wealth distribution shows that an important explanation for the little interest in annuities comes from the fact that annuities are extremely expensive, compared with the total accumulated assets held by households. In other words many households can not afford even to enter the annuity market. The paper also compares the simulated annuity demand to the actual demands reported in the Family Resources Survey. For those individuals who buy annuities, the simulated demands are not very different from those observed in the survey.

Suggested Citation

  • Lopes, Paula, 2003. "Are annuities value for money?: who can afford them?," LSE Research Online Documents on Economics 24899, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:24899

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    References listed on IDEAS

    1. John Y. Campbell & João F. Cocco, 2003. "Household Risk Management and Optimal Mortgage Choice," The Quarterly Journal of Economics, Oxford University Press, vol. 118(4), pages 1449-1494.
    2. Tauchen, George & Hussey, Robert, 1991. "Quadrature-Based Methods for Obtaining Approximate Solutions to Nonlinear Asset Pricing Models," Econometrica, Econometric Society, vol. 59(2), pages 371-396, March.
    3. 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.
    4. Deaton, Angus, 1991. "Saving and Liquidity Constraints," Econometrica, Econometric Society, vol. 59(5), pages 1221-1248, September.
    5. Jeffrey Brown, 2001. "Are the Elderly Really Over-Annuitized? New Evidence on Life Insurance and Bequests," NBER Chapters,in: Themes in the Economics of Aging, pages 91-126 National Bureau of Economic Research, Inc.
    6. Jeffrey R. Brown & Olivia S. Mitchell & James M. Poterba, 2001. "The Role of Real Annuities and Indexed Bonds in an Individual Accounts Retirement Program," NBER Chapters,in: Risk Aspects of Investment-Based Social Security Reform, pages 321-370 National Bureau of Economic Research, Inc.
    7. Orazio P. Attanasio & Hilary Williamson Hoynes, 2000. "Differential Mortality and Wealth Accumulation," Journal of Human Resources, University of Wisconsin Press, vol. 35(1), pages 1-29.
    8. Kotlikoff, Laurence J & Summers, Lawrence H, 1981. "The Role of Intergenerational Transfers in Aggregate Capital Accumulation," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 706-732, August.
    9. Amy Finkelstein & James Poterba, 1999. "Selection Effects in the Market for Individual Annuities: New Evidence from the United Kingdom," NBER Working Papers 7168, National Bureau of Economic Research, Inc.
    10. Benjamin M. Friedman & Mark J. Warshawsky, 1990. "The Cost of Annuities: Implications for Saving Behavior and Bequests," The Quarterly Journal of Economics, Oxford University Press, vol. 105(1), pages 135-154.
    11. Benjamin M. Friedman & Mark Warshawsky, 1985. "The Cost of Annuities: Implications for Saving Behavior and Bequests," NBER Working Papers 1682, National Bureau of Economic Research, Inc.
    12. Amy Finkelstein & James Poterba, 2002. "Selection Effects in the United Kingdom Individual Annuities Market," Economic Journal, Royal Economic Society, vol. 112(476), pages 28-50, January.
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    Cited by:

    1. Lopes, Paula & Michaelides, Alexander, 2007. "Rare events and annuity market participation," Finance Research Letters, Elsevier, vol. 4(2), pages 82-91, June.

    More about this item


    Annuities; Inflation risk; Real interest rate risk; Mortality risk;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth


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