Health Cost Risk: A Potential Solution to the Annuity Puzzle
Forthcoming The Economic Journal
41 Pages Posted: 19 Feb 2010 Last revised: 21 Feb 2019
Date Written: September 30, 2015
We find that health cost risk lowers optimal annuity demand at retirement. If medical expenses can be sizeable early in retirement, full annuitisation at retirement is no longer optimal because agents do not have enough time to build a liquid wealth buffer. Furthermore, large deviations from optimal annuitisation levels lead to small utility differences. Our results suggest that health cost risk can explain a large proportion of empirically observed annuity choices. Finally, allowing additional annuitisation after retirement results in welfare gains of at most 2.5% when facing health cost risk, and negligible gains without this risk.
Keywords: Life-cycle portfolio choice, retirement, post-retirement investment
JEL Classification: D14, D91, G11, I1
Suggested Citation: Suggested Citation