Health State Transitions and Longevity Effects on Retirees’ Optimal Annuitization

25 Pages Posted: 14 Apr 2017

See all articles by Jing Ai

Jing Ai

University of Hawaii at Manoa - Shidler College of Business

Patrick L. Brockett

University of Texas at Austin - Department of Information, Risk and Operations Management

Linda L. Golden

University of Texas at Austin - Red McCombs School of Business

Wei Zhu

University of International Business and Economics (UIBE)

Date Written: April 2017

Abstract

The interplay between longevity risk and health state transitions for retirees’ optimal annuitization decisions is investigated. Using a life‐cycle framework incorporating wealth levels, bequest motives, and consumption floors created by government subsidies, we examine how increased longevity in conjunction with an individual's health state transition process impacts annuity purchase decisions. Health state transition matrices are estimated from the Health and Retirement Survey (HRS) data. The effects of increased longevity on annuitization decisions are considered when longevity is both accompanied by increased time spent in healthier states (morbidity compression) or experienced by more time in unhealthy states (morbidity expansion). We find that retirees’ annuity demand is affected by wealth, initial health status, and expansion or compression of morbidity. Wealthier retirees have higher annuity demand when health shocks are considered, and increased longevity increases demand even more when retirees expect an expansion or slight morbidity compression. With health shocks and expectations of severe morbidity compression considered, the opposite effect might occur. Thus, an annuity can help retirees hedge health shock costs when slight compression or expansion of morbidity occurs. For retirees with lower wealth, the consumption floor provided by governmental subsidies will create a decreased propensity to annuitize.

Suggested Citation

Ai, Jing and Brockett, Patrick L. and Golden, Linda L. and Zhu, Wei, Health State Transitions and Longevity Effects on Retirees’ Optimal Annuitization (April 2017). Journal of Risk and Insurance, Vol. 84, Issue S1, pp. 319-343, 2017, Available at SSRN: https://ssrn.com/abstract=2952787 or http://dx.doi.org/10.1111/jori.12168

Jing Ai (Contact Author)

University of Hawaii at Manoa - Shidler College of Business ( email )

2404 Maile Way
Honolulu, HI 96822
United States

Patrick L. Brockett

University of Texas at Austin - Department of Information, Risk and Operations Management ( email )

CBA 5.202
Austin, TX 78712
United States

Linda L. Golden

University of Texas at Austin - Red McCombs School of Business ( email )

Austin, TX 78712
United States

Wei Zhu

University of International Business and Economics (UIBE) ( email )

10, Huixin Dongjie
Changyang District
Beijing, Beijing 100029
China

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