The Annuity Puzzle: How Big is the Free Lunch Being Left on the Table?

Abstract

The looming Savings Crisis is usually attributed to people either not saving enough or making poor investment choices, but we believe there's another culprit. Many investors could benefit from a 'free lunch' of pooling their longevity risk with others, but due to market inefficiencies, they do not. We quantify the size of this missed opportunity gap using an Expected Utility framework to compare self-managed savings versus the purchase of a zero-fee annuity.

Keywords: savings crisis, market inefficiency, expected utility, zero-fee annuity, longevity risk, long-term savings, self-managed savings

JEL Classification: B12, B16, B20, C00, C10, C11, C50, C57, C73, D03, D81, D83, E00, G00, G02, G11, G12, G14, G17, G23