Annuity and Insurance Choice Under Habit Formation
44 Pages Posted: 1 May 2020
Date Written: April 6, 2020
This paper examines the impact of habit formation on the demand for life-contingent contracts in a life-cycle model. We derive an analytical solution for the optimal consumption, portfolio choice, and life insurance/annuity purchases. We illustrate the mechanism by which the consumption habit assumption can alter the bequest motive and therefore drive the demand for life-contingent products. We show that habit formation alone can either explain the life insurance puzzle or the annuity puzzle but not both. However, habit formation together with social security can help explain both puzzles.
Keywords: Habit Formation; Life-Cycle Model; Life Insurance; Annuity
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