Individual Welfare Gains from Deferred Life-Annuities Under Stochastic Mortality

Abstract

At the end of the deferment period a deferred annuity’s policyholder can choose between receiving annuity payouts or the capital accumulated. Considering stochastic mortality improvements, the lump-sum option could be of potential value for the policyholder. Whenever mortality improves less than expected at contract inception, the policyholder will choose the lump-sum and buy an annuity at current market prices. Otherwise, he will retain the more favorable deferred annuity. We use a realistically calibrated life-cycle model and calculate the welfare gains of deferred annuities considering stochastic mortality. Our results are relevant for individual retirement planning, pension system design, and insurance pricing.

Keywords: stochastic mortality, deferred annuitization, retirement decisions, dynamic intertemporal utility maximization

JEL Classification: D14, D81, D91, G11, G22, J11, J26