What Makes a Better Annuity?

41 Pages Posted: 8 May 2009

See all articles by Jason S. Scott

Jason S. Scott

Financial Engines, Inc.

John G. Watson

Financial Engines, Inc.; Stanford Graduate School of Business

Wei-Yin Hu

Financial Engines, Inc.

Multiple version iconThere are 2 versions of this paper

Date Written: May 5, 2009

Abstract

The wide gulf between actual and predicted annuity demand has been well documented. However, a comparable gap exists between the current and ideal annuity market. In a world with costly and limited annuity products, we investigate what types of new annuity products could improve annuity market participation and increase individual welfare. We find that participation gains are most likely for new annuity products that focus on late-life payouts which offer a large price discount relative to their financial market analogues. For example, the marginal utility from the first dollar allocated to a late-life annuity can be several times that of an immediate annuity. Our welfare analysis indicates that an individual’s current assets suggest desirable new annuity products since annuities that lower the cost of the existing consumption plan necessarily improve welfare. Finally, we consider the implications for annuity demand if new annuity products ultimately complete the annuity market. Given access to a complete market, we find all individuals only purchase annuity contracts with a significant time gap between purchase and payout. At a minimum, enough time must pass between purchase and payout to build up a mortality discount sufficient to overcome the cost of creating the contract. Since most existing annuity products, such as immediate annuities, do not have this feature, few current annuity contract configurations are likely to survive significant product innovation. Taken together, our results indicate that there is ample opportunity for innovation to spur annuity demand and improve individual welfare.

Keywords: Annuity, longevity, insurance, pensions, welfare

JEL Classification: D11, D91, E21, H55, J14, J26

Suggested Citation

Scott, Jason S. and Watson, John G. and Hu, Wei-Yin, What Makes a Better Annuity? (May 5, 2009). Available at SSRN: https://ssrn.com/abstract=1399785 or http://dx.doi.org/10.2139/ssrn.1399785

Jason S. Scott (Contact Author)

Financial Engines, Inc. ( email )

1050 Enterprise Way, 3rd Floor
Sunnyvale, CA 94089
United States

John G. Watson

Financial Engines, Inc. ( email )

1050 Enterprise Way
Sunnyvale, CA 94089
United States

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305
United States

Wei-Yin Hu

Financial Engines, Inc. ( email )

1050 Enterprise Way, 3rd Floor
Sunnyvale, CA 94089
United States

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