Optimal Portfolio Choice with Health-Contingent Income Products: The Value of Life Care Annuities
ARC Centre of Excellence in Population Aging Research Working Paper 2016/17
41 Pages Posted: 3 Aug 2016
Date Written: July 1, 2016
Whereas there is ample evidence that life-contingent income products (life annuities) have the potential to improve individual welfare, combining them with health-contingent income products (resulting in so-called life care annuities) would serve to further increase welfare for individuals who are exposed to uncertain out-of-pocket healthcare expenditure later in life. We develop a life-cycle model of annuitization, consumption, and investment decisions for a single retired individual who faces stochastic capital market returns, uncertain health status, differential mortality risks, and uncertain out-of-pocket healthcare expenditure with cost of dying. Using the calibrated model, we show that individuals who are eligible to purchase life care annuities instead of standard life annuities increase their level of annuitization by around 12 percentage points. Health status at retirement affects the extent to which the insurance feature and the pricing advantage of life care annuities contribute to this increment, with end-of-life healthcare expenditure being of particular importance. Also, life care annuities allow individuals to consume more throughout their retirement and to invest a higher proportion of their liquid wealth in the risky asset. They are willing to pay a loading up to 21% for having access to life care annuities.
Keywords: Life-cycle portfolio choice, Long-term care insurance, Retirement, Household finance.
JEL Classification: D91, D14, G11, I13, H55, J32
Suggested Citation: Suggested Citation