Optimizing the Equity-Bond-Annuity Portfolio in Retirement: The Impact of Uncertain Health Expenses
Mark J. Warshawsky
Social Security Advisory Board; Towers Watson
December 1, 2007
Insurance: Mathematics and Economics, 2009
This paper derives optimal equity-bond-annuity portfolios for households who face stochastic capital market returns, differential exposures to mortality risk and uncertain uninsured health expenses, and differential Social Security and defined benefit pension coverage. The results show that the health spending risk drives household portfolios to shift from risky equities to safer assets and enhances the demand for annuities due to their increasing-with-age superiority over bonds in hedging against life-contingent health spending and longevity risks. Households with higher income have a greater incremental demand for life annuities. The safe and higher-return annuities in turn provide a greater leverage for equity investment in the remaining asset portfolios.
Number of Pages in PDF File: 38
Keywords: annuity, asset allocation, health expense, precautionary savings, Social Security, pension, lifecycle
JEL Classification: D12, D31, D91, G11, H55, I10, J32working papers series
Date posted: December 20, 2007 ; Last revised: September 28, 2009
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