Optimal Portfolio Choice in Retirement with Participating Life Annuities

31 Pages Posted: 13 Nov 2014

See all articles by Ralph Rogalla

Ralph Rogalla

St. John's University - Tobin College of Business - School of Risk Management, Insurance, and Actuarial Science; Goethe University Frankfurt - Department of Finance

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Date Written: September 1, 2014

Abstract

This paper derives optimal consumption, investment, and annuitization patterns for retired households that have access to German-style participating payout life annuities (PLAs), allowing for capital market risks as well as idiosyncratic and systematic longevity risks. PLAs provide guaranteed minimum benefits in combination with participation in insurers' surpluses. Minimum benefits are calculated based on conservative assumptions regarding capital market and mortality developments, while surpluses distributed to annuitants bridge the gap between the insurers' actual investment and mortality experiences and the projections used in pricing. Through the participation scheme, systematic longevity risk is shared between insurers and annuitants, as unanticipated longevity shocks result in benefit adjustments via the surplus mechanism.

We show that the retiree draws substantial utility from access to PLAs, equivalent to 20 percent of initial wealth in the presence of systematic longevity risk. We also find that stochasticity in mortality rates only has minor impact on the appeal of PLAs to the retiree. Even if the interest rate guarantee is reduced to zero in adverse capital market environments, PLAs prove to provide substantial utility for retirees. Overall, the participating life annuity design produces substantial welfare gains over a no-annuity world, while being an efficient setup that helps providers to hedge long-term risks that are difficult to hedge otherwise, such as systematic longevity risks.

Keywords: Life-cycle investing, annuitization, stochastic mortality, pension, household finance

JEL Classification: D14, G11, G22

Suggested Citation

Rogalla, Ralph, Optimal Portfolio Choice in Retirement with Participating Life Annuities (September 1, 2014). Pension Research Council WP 2014-20. Available at SSRN: https://ssrn.com/abstract=2523582 or http://dx.doi.org/10.2139/ssrn.2523582

Ralph Rogalla (Contact Author)

St. John's University - Tobin College of Business - School of Risk Management, Insurance, and Actuarial Science ( email )

101 Astor Place
New York, NY 10003
United States

Goethe University Frankfurt - Department of Finance ( email )

House of Finance
Grueneburgplatz 1
Frankfurt am Main, Hessen 60323
Germany

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