Working Paper: NBER ID: w1682
Authors: Benjamin M. Friedman; Mark Warshawsky
Abstract: The fact that most eldealy individuals in the United States choose to maintain a flat age-wealth profile, rather than buy individual life annuities, stands in contrast to central implications of the standard life-cycle model of consumption-saving behavior. The analysis in this paper lends support to an explanation for this phenomenon based either on the cost of annuities, importantly including the element of that cost due to adverse selection, or on the interaction of that cost and an intentional bequest motive. Expected yields offered on individual life annuities in the United States are lower by some 4-6%, or 2 1/2-4 1/2% after allowing for adverse selection, than yields on alternative long-term fixed-income investments. Simulations of an extended model of life-cycle saving and portfolio behavior, allowing explicitly for uncertain lifetimes and Social Security, show that yield differentials in this range can account for the observed behavior, even in the absence of a bequest motive, during the early years of retirement. By contrast, at older ages the combination of yield differentials in this range and a positive bequest motive is necessary to do so.
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Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| perceived cost of annuities (G22) | decision not to buy them (D80) |
| yield differential (E43) | preference to maintain a flat age-wealth profile (D15) |
| yield differential + positive bequest motive (D15) | observed behavior of elderly individuals regarding annuities (J26) |