Optimizing the Equity-Bond-Annuity Portfolio in Retirement: The Impact of Uncertain Health Expenses

38 Pages Posted: 20 Dec 2007 Last revised: 28 Sep 2009

See all articles by Gaobo Pang

Gaobo Pang

Northern Trust Asset Management

Mark J. Warshawsky

Towers Watson; Mercatus Center at George Mason University

Date Written: December 1, 2007

Abstract

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.

Keywords: annuity, asset allocation, health expense, precautionary savings, Social Security, pension, lifecycle

JEL Classification: D12, D31, D91, G11, H55, I10, J32

Suggested Citation

Pang, Gaobo and Warshawsky, Mark J., Optimizing the Equity-Bond-Annuity Portfolio in Retirement: The Impact of Uncertain Health Expenses (December 1, 2007). Insurance: Mathematics and Economics, 2009. Available at SSRN: https://ssrn.com/abstract=1077633 or http://dx.doi.org/10.2139/ssrn.1077633

Gaobo Pang (Contact Author)

Northern Trust Asset Management ( email )

50 South LaSalle Street
Chicago, IL 60603
United States
3126306980 (Phone)

HOME PAGE: http://www.northerntrust.com

Mark J. Warshawsky

Towers Watson ( email )

Arlington, VA
United States

Mercatus Center at George Mason University

3434 Washington Blvd., 4th Floor
Arlington, VA 22201
United States

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