Why Don't the People Insure Late Life Consumption?

Abstract (Via Ideas 42)

Rational models of risk-averse consumers have difficulty explaining limited annuity demand. We posit that consumers evaluate annuity products using a narrow “investment frame” that focuses on risk and return, rather than a “consumption frame” that considers the consequences for lifelong consumption. Under an investment frame, annuities are quite unattractive, exhibiting high risk without high returns. Survey evidence supports this hypothesis: whereas 72 percent of respondents prefer a life annuity over a savings account when the choice is framed in terms of consumption, only 21 percent of respondents prefer it when the choice is framed in terms of investment features.

Introduction (Via Ideas 42)

According to standard economic models, a risk-averse consumer who faces uncertainty about length-of-life should place a high value on life annuities that provide guaranteed income for life. Yet numerous studies show that few consumers voluntarily annuitize their retirement savings. As public and private pension systems around the world continue the ongoing shift from traditional defined benefit plans, which typically pay benefits for life, to defined contribution structures which rarely require annuitization, retirees find themselves increasingly exposed to longevity risk – the risk of being unable to sustain their consumption should they live longer than average.

Additional Excerpt (Via Ideas 42)

The above model implicitly has two components: an investment component, in which the individual decides how much to invest in each asset, and a consumption component, in which she decides how to spend the money from that investment. We propose that instead of viewing the problem through the consumption frame (focusing on the end result of what can be spent over time), many consumers adopt an investment frame (focusing on the intermediate results of return and risk features when choosing assets and not considering the consequences for consumption).

Practically, this framework suggests that the unattractive feature of the annuity in the investment frame will be the potential for the investment to have a negative return. This matches the qualitative intuition that practitioners provide: people react negatively to the possibility that they could lose money.

Findings (Via Ideas 42)

This finding provokes the immediate question: if framing matters, why don’t annuity providers use the consumption frame? We conjecture that the investment frame is the dominant frame in the market and in most younger customers’ minds both because it is simpler, due to the focus on nearer-term and impersonal outcomes, and because little is lost by using this frame during the wealth accumulation stage of life.

Click Here To Read: Why Don’t the People Insure Late Life Consumption? A Framing Explanation of the Under-Annuitization Puzzle

About Miguel Barbosa

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04. January 2010 by Miguel Barbosa
Categories: Behavioral Economics, Curated Readings | Leave a comment

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