Cognitive Constraints on Valuing Annuities
42 Pages Posted: 29 Jun 2013 Last revised: 18 May 2023
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Decision Complexity as a Barrier to Annuitization
Decision Complexity as a Barrier to Annuitization
Date Written: June 2013
Abstract
We show that people have difficulty valuing annuities, and this, instead of a preference for lumpsums, helps explain observed low annuity demand. Although the median price at which people are willing to sell an annuity stream is close to the actuarial value, many responses diverge greatly from optimizing behavior. Moreover, people will pay substantially less to buy than to sell annuities. We conclude that boundedly rational consumers adopt "buy low, sell high" heuristics when confronting a complex trade-off. This suggests that many consumers do not make optimizing decisions, underscoring the difficulty of explaining cross-sectional annuity valuation differences using standard models.
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