creator: Webb, Anthony
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Evaluating the Advanced Life Deferred Annuity - An Annuity People Might Actually Buy
description- – Although annuities provide longevity insurance that should, in theory, be attractive to risk-averse households facing an uncertain lifespan, rates of voluntary annuitization remain extremely low. We evaluate a proposed annuity product, the Advanced Life Deferred Annuity, an annuity purchased at retirement, providing an income commencing in advanced old age. Using numerical optimization techniques, we show that this product would provide a substantial proportion of the longevity insurance provided by an immediate annuity, at a small fraction of the cost. At plausible levels of actuarial unfairness, households should prefer it to both immediate and postponed annuitization, and an optimal decumulation of unannuitized wealth. We show that few households would suffer significant losses were it used as a 401(k) plan default.
- – wp_2007_15
- – 2007-09-01
- – application/pdf
Annuitization: Keeping Your Options Open
description- – Annuities provide insurance against outliving one's wealth. Previous studies have indicated that, for many households, the value of the longevity insurance should outweigh the actuarial unfairness of prices in the voluntary annuity market. Nonetheless, voluntary annuitization rates are extremely low. Previous research on the value of annuitization has compared the alternative of an optimal decumulation of unannuitized wealth with the alternative of annuitizing all unannuitized wealth at age 65. We relax these assumptions, allowing households to annuitize any part of their unannuitized wealth at any age and to return to the annuity market as many times as they wish. Using numerical optimization techniques, and retaining the assumption made in previous research that half of the household wealth is pre-annuitized, we conclude that it is optimal for couples to delay annuitization until they are aged 74 to 89, and in some cases never to annuitize. It is usually optimal for single men and women to annuitize at substantially younger ages, around 65 and 70 respectively. Households that annuitize will generally wish to annuitize only part of their unannuitized wealth. Using data from the Asset and Health Dynamics Among the Oldest Old and Health and Retirement Study panels, we show that much of the failure of the average currently retired household to annuitize can be attributed to the exceptionally high proportion of the wealth of these cohorts that is pre-annuitized. We expect younger cohorts to have smaller proportions of pre-annuitized wealth and we project increasing demand for annuitization as successive cohorts age.
- – 2004-03-01
- – application/pdf
Life is Cheap: Using Mortality Bonds to Hedge Aggregate Mortality Risk
description- – Using the Lee-Carter mortality model, we quantify aggregate mortality risk, the risk that annuitants might live longer than predicted by the model. We calculate that a markup of 4.3 percent on an annuity premium, or else shareholders' capital equal to 4.3 percent of the expected present value of annuity payments, would reduce the probability of insolvency resulting from uncertain aggregate mortality trends to five percent, and a markup of 6.1 percent would reduce the probability of insolvency to one percent. Using the same model, we find evidence that the projection scale that the insurance industry commonly refers to underestimates aggregate mortality improvements. Consequently, annuities that are priced on that projections scale without any conservative margin will be substantially underpriced. Insurance companies could deal with aggregate mortality risk by transferring it to the financial markets through newly-available mortality-contingent bonds. We calculate the returns that investors would have obtained on such bonds had they been available previously, and the historical covariance between these bond returns and the growth in per-capita consumption. Using the Consumption Capital Asset Pricing Model (CCAPM), we determine the risk premium that investors would have required on such bonds. At plausible coefficients of risk aversion, investors should be able to hedge aggregate mortality risk via such bonds at very low cost.
- – 2005-10-01
- – application/pdf
The Impact of Aggregate Mortality Risk on Defined Benefit Pension Plans
description- – We calculate the risk faced by defined benefit plan providers arising from uncertain aggregate mortality -- the risk that the average participant will live longer than expected. First, comparing the widely cited Lee-Carter model to industry benchmarks, we show that plan providers appear to substantially underestimate the longevity of their employees. The resultant understatement of liabilities is 15.2 percent, when weighted by the characteristics of typical male participants in defined benefit plans, and reaches as much as 25.2 percent for male workers aged 22. Next, we consider the substantial mortality risk that arises even if plan providers were to use the Lee-Carter model or other unbiased forecasts of mortality reductions. We calculate the consequences for plan liabilities if aggregate mortality declines unexpectedly faster than is predicted by an unbiased projection. There is a 5 percent chance that liabilities of a terminated plan would be 2.9 to 5.1percent higher than what is expected, depending on the mix of workers covered. Lastly, we explain how longevity bonds might be used to transfer mortality risk from defined benefit plans to the capital markets, and we calculate a risk premium for a hypothetical frozen plan.
- – 2006-11-01
- – application/pdf
Optimal Retirement Asset Decumulation Strategies: The Impact of Housing Wealth
description- – A considerable literature examines the optimal decumulation of financial wealth in retirement. We extend this line of research to incorporate housing, which comprises the majority of most households' non-pension wealth. We use VARs to estimate the relationship between the returns on housing, stocks, and bonds, and use simulation techniques to investigate a variety of decumulation strategies incorporating reverse mortgages. Under a wide variety of assumptions, we find that the average household would be as much as 33 percent better off taking a reverse mortgage as a lifetime income relative to what appears to be the most common strategy of delaying until financial wealth is exhausted and then taking a line of credit. It would be as much as 62 percent better off relative to not taking a reverse mortgage at all. Housing wealth displaces bonds in optimal portfolios, making the low rate of participation in the stock market even more of a puzzle.
- – 2006-11-01
- – application/pdf
Determinants and Consequences of Bargaining Power in Households
description- – A growing literature offers indirect evidence that the distribution of bargaining power within a household influences decisions made by the household. These results undermine the notion that a household can be treated as a"unitary"decision maker. The indirect evidence links household outcomes to variables that are assumed to influence the distribution of bargaining power within the household. In this paper, we have data on whether a husband or wife in the Health and Retirement Study"has the final say"when making major decisions in a household. We use this variable to analyze determinants and some consequences of bargaining power. Our analysis overcomes endogeneity problems arising in many earlier studies and constitutes the missing link confirming the importance of household bargaining models. We find that decision-making power depends on plausible variables within the household and also influences important household outcomes, and moreover that the second set of results is much stronger than the first set. While current and lifetime earnings significantly affect decision-making power, the effects are moderate. On the other hand, decision-making power has important effects on financial decisions like stock market investment and total wealth accumulation and may help explain, for example, the relatively high poverty rate among widows. Thus, our results suggest that more research into the determination of bargaining power is needed, and that household bargaining has major effects on the welfare of household members.
- – 2006-06-01
- – application/pdf
Mortality Heterogeneity and The Distributional Consequences of Mandatory Annuitization
description- – Using data from the Health and Retirement Study (HRS), we calculate the relationship between socio-economic status and a utility based measure of annuity value. We find considerable variation between groups once we take account of not only socio-economic differences in mortality, but also pre-annuitized wealth and longevity risk pooling in marriage. Using HRS data on subjective survival probabilities, we then construct a subjective life table for each individual in the HRS. We show that these tables vary appropriately between groups and aggregate closely to group level averages. We calculate the value each household would place on annuitization, based on the husband and wife's subjective life tables, and the household's degree of risk-aversion and proportion of pre-annuitized wealth. A significant minority would perceive themselves as suffering a net loss from mandatory annuitization.
- – 2006-05-01
- – application/pdf
What Moves the National Retirement Risk Index? A Look Back and an Update
description- – In June 2006, the Center for Retirement Research released the National Retirement Risk Index (NRRI). The results showed that even if households work to age 65 and annuitize all their financial assets, including the receipts from reverse mortgages on their homes, 43 percent will be at risk of being unable to maintain their standard of living in retirement. Households are more likely to be 'at risk' if they are young, have low incomes, or lack pension coverage. This brief looks at the three major factors that have caused the Index to increase since the early 1980s. These factors are: 1) a decline in Social Security replacement rates due to the decline in one-earner couples and the increase in Social Security's Normal Retirement Age; 2) lower pension replacement rates as a result of the shift from defined benefit to defined contribution plans; and 3) lower annuity payments due to the dramatic decline in real interest rates. These negative factors have been only partially offset by a modest increase in financial assets, and an increase in the retirement income that homeowners could potentially obtain through reverse mortgages. Having identified the key movers, this brief also updates the Index from 2004 to 2006. During this period, the run-up in housing prices was cancelled out by a corresponding surge in mortgage debt, which resulted in no change in the 'at risk' status of any of the Index's age cohorts. However, compared to the 2004 Index, the 2006 Index has more Generation Xers and fewer Baby Boomers. Since Generation Xers are more likely to be 'at risk,' this change increased the Index slightly to 44 percent.
- – 2007-01-01
- – application/pdf
Households 'At Risk': A Closer Look at the Bottom Third
description- – The Center's National Retirement Risk Index (NRRI) provides a measure of the percentage of households that will be unable to maintain their standard of living in retirement. Issued in June 2006 with numbers based on the 2004 Federal Reserve's Survey of Consumer Finances, the Index shows that 43 percent of the population will be 'at risk.' 'At risk' means different things, however, for households in different parts of the income distribution. For those in the top third, 'at risk' may require cutting back on some of the normal amenities enjoyed before retirement, but for those in the bottom third 'at risk' may mean foregoing essentials. This brief takes a closer look at the NRRI for the bottom third of the population. The brief focuses on three issues. The first is the relative change in the NRRI for the bottom third as opposed to the upper two-thirds over the period 1983-2004. Although the percent 'at risk' remains consistently higher for the bottom third, the situation for those at the low end of the income scale deteriorated less over the period than it did for the top two-thirds of households. The reason is that two of the main drivers -- the shift from defined benefit to defined contribution plans and the decline in real interest rates -- were less relevant for those at the low end of the income scale. The second issue pertains to the outlook for the bottom third going forward. Because the bottom third of households relies almost entirely on Social Security in retirement, the continued increase in the Normal Retirement Age (NRA) will raise the percentage 'at risk.' The final section explores the implication of the increase in the percentage of households in the bottom third 'at risk' for poverty among the elderly in the future.
- – 2007-01-01
- – application/pdf
Persistence in Labor Supply and the Response to the Social Security Earnings Test
description- – This paper investigates the impact on labor supply of changes in the Social Security earnings test in 1996 and 2000. We highlight how the persistence of labor supply choices influences both responses to policy changes and the estimation of such responses. We do this in two ways. First, we use data from the Health and Retirement Study and the Current Population Survey that allows us to compare employment transitions across cohorts that are differentially affected by changes in the earnings test rules. We show that conditioning on last year's employment status is important in identifying responses to current earnings test changes. Second, we test the effect of not only current but also anticipated as well as past earnings test parameters which cohorts faced at earlier ages. We find that past and anticipated future rules influence current employment and earnings. Our results help to identify an effect of earnings test changes affecting ages 65-69 on employment at younger and older ages, which suggests caution about the use of neighboring age groups as control groups in analyzing responses to the earnings test. We also show that earnings test changes that were initiated in 1996 had an important effect, in addition to the changes in 2000 that have been extensively studied.
- – 2006-12-01
- – application/pdf
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