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Annuity Prices and Saving Behavior in the United States

  • Benjamin M. Friedman
  • Mark Warshawsky
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    The observed reluctance of most individuals in the United States to buy individual life annuities, and the concomitant approximately flat average age-wealth profile, stand in sharp contradiction to the standard life cycle model of consumption-saving behavior. The analysis in this paper lends support to an explanation for this phenomenon based on the interaction of an intentional bequest motive and annuity prices that are not actuarially fair. Premiums charged for individual life annuities in the United States include a load factor of 32-48c per dollar,or18-33c per dollar after allowing for adverse selection, in comparison to actuarially fair annuity values. Load factors of this size are not out of line with those on other familiar (and almost universally purchased) insurance products. Simulations of an extended model of life cycle saving and portfolio behavior, allowing explicitly for uncertain lifetimes and Social Security, show that the load factor charged would have to be far larger than this to account for the observed behavior in the absence of a bequest motive. By contrast, the combination of a load factor in this range and a positive bequest motive can do so for some plausible values of the assumed underlying parameters. Moreover,if this combination of factors is leading elderly individuals to avoid purchasing life annuities, it implies a typical bequest that is fairly large in comparison to their consumption.

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    File URL: http://www.nber.org/papers/w1683.pdf
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    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1683.

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    Date of creation: Aug 1985
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    Publication status: published as Bodie, Z., J. Shoven, D. Wise (eds.) Pensions in the U.S. Economy. Chicago: University of Chicago Press, 1988.
    Handle: RePEc:nbr:nberwo:1683
    Note: ME
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    1. B. Douglas Bernheim & Andrei Shleifer & Lawrence H. Summers, 1984. "Bequests as a Means of Payment," NBER Working Papers 1303, National Bureau of Economic Research, Inc.
    2. Friend, Irwin & Blume, Marshall E, 1975. "The Demand for Risky Assets," American Economic Review, American Economic Association, vol. 65(5), pages 900-922, December.
    3. Pratt, John W & Wise, David A & Zeckhauser, Richard, 1979. "Price Differences in Almost Competitive Markets," The Quarterly Journal of Economics, MIT Press, vol. 93(2), pages 189-211, May.
    4. Zvi Bodie & Alex Kane & Robert McDonald, 1985. "Inflation and the Role of Bonds in Investor Portfolios," NBER Chapters, in: Corporate Capital Structures in the United States, pages 167-196 National Bureau of Economic Research, Inc.
    5. Rothschild, Michael & Stiglitz, Joseph E, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 630-49, November.
    6. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-91, March.
    7. Laurence J. Kotlikoff & Lawrence H. Summers, 1980. "The Role of Intergenerational Transfers in Aggregate Capital Accumulation," NBER Working Papers 0445, National Bureau of Economic Research, Inc.
    8. Grossman, Sanford J & Shiller, Robert J, 1981. "The Determinants of the Variability of Stock Market Prices," American Economic Review, American Economic Association, vol. 71(2), pages 222-27, May.
    9. Laurence J. Kotlikoff & Avia Spivak, 1979. "The Family as an Incomplete Annuities Market," NBER Working Papers 0362, National Bureau of Economic Research, Inc.
    10. Mirer, Thad W, 1979. "The Wealth-Age Relation among the Aged," American Economic Review, American Economic Association, vol. 69(3), pages 435-43, June.
    11. Davies, James B, 1981. "Uncertain Lifetime, Consumption, and Dissaving in Retirement," Journal of Political Economy, University of Chicago Press, vol. 89(3), pages 561-77, June.
    12. Fischer, Stanley, 1973. "A Life Cycle Model of Life Insurance Purchases," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 14(1), pages 132-52, February.
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