Too risk averse to purchase insurance?
- 696 Downloads
This paper suggests a new explanation for the low level of annuitization, which is valid even if one assumes perfect markets. We show that, as soon there is a positive bequest motive, sufficiently risk averse individuals should not purchase annuities. A model calibration accounting for lifetime risk aversion generates a significantly smaller willingness-to-pay for annuities than the one generated by a standard time-additive model. Moreover, the calibration predicts that riskless savings finance one third of consumption, in line with empirical findings.
KeywordsAnnuity puzzle Insurance demand Bequest Intergenerational transfers Risk aversion Multiplicative preferences
JEL ClassificationsD11 D81 D91
We are grateful to Edmund Cannon, Alexis Direr, Glenn Harrison, Lee Lockwood, Thomas Post, James Poterba, Ray Rees, Harris Schlesinger (the editor), an anonymous referee and seminar participants at ETH Zurich, University of Paris I, University of Zurich, 2011 Summer Meetings of the Econometric Society and CEAR/MRIC Behavioral Insurance Workshop 2012 (LMU, Münich) for their comments.
- Andersen, S., Harrison, G., Lau, M., Rutstroem, E. (2011). Multiattribute utility theory, intertemporal utility and correlation aversion. CEAR Working Paper 2011-04, Georgia State University.Google Scholar
- Bommier, A. (2007). Risk aversion, intertemporal elasticity of substitution and correlation aversion. Economics Bulletin, 4(29), 1–8.Google Scholar
- Bommier, A. (2013). Life cycle preferences revisited. Journal of European Economic Association, 11(6), 1290-1319.Google Scholar
- Bommier, A., & LeGrand, F. (2013). Too risk averse to purchase insurance? A theoretical glance at the annuity puzzle. CER-ETH Working Paper 12/157, ETH Zurich. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1991085.
- Brown, J.R. (2007). Rational and behavioral perspectives on the role of annuities in retirement planning. NBER Working Paper 13537, National Bureau of Economic Research.Google Scholar
- Drèze, J., & Rustichini, A. (2004). State-dependent utility and decision theory, 2: extensions. Dordrecht In S. Barbera PH, & C. Seild (Eds.), Handbook of utility theory, (pp. 839–892): Kluwer Academic Publishers.Google Scholar
- Eden, B (2008). Substitution, risk aversion and asset prices: an expected utility approach. Working Paper 0803, Department of Economics, Vanderbilt University.Google Scholar
- Gazzale, R. S., & Walker, L. (2011). I’ll cross that bridge if I get to it: focusing on the near future. Working Paper, University of Toronto.Google Scholar
- Hurd, M. D., & Smith, J. P. (2002). Expected bequests and their distribution. NBER Working Paper 9142, National Bureau of Economic Research.Google Scholar
- James, E., & Song, X. (2001). Annuities markets around the world: money’s worth and risk intermediation. CeRP Working Paper 16/01, Center for Research on Pensions and Welfare Policies.Google Scholar
- Johnson, R. W., Burman, L. E., Kobes, D. I. (2004). Annuitized wealth at older ages. Evidence from the health and retirement study. Final report to the Employee Benefits Security Administration of the U.S. Department of Labor, The Urban Institute.Google Scholar
- Livingston, G., & Cohn, D. (2010). The new demography of American motherhood. A Social and Demographic Trends Report, Pew Research Center.Google Scholar
- Lockwood, L. M. (2012b). Bequest motives and the choice to self-insure late-life risks. Working Paper, Northwestern University.Google Scholar
- Ponzetto, G. (2003). Risk aversion and the utility of annuities. CeRP Working Paper 31/03, Center for Research on Pensions and Welfare Policies.Google Scholar
- Sinclair, S. M., & Smetters, K. A. (2004). Health shocks and the demand for annuities. Technical Paper 2004-9, Congressional Budget Office.Google Scholar
- Van den Heuvel, S. J. (2008). Temporal risk aversion and asset prices. Working Paper 2008-37, Federal Reserve Board.Google Scholar
- Yogo, M. (2009). Portfolio choice in retirement: health risk and the demand for annuities, housing and risky assets. NBER Working Paper 15307, National Bureau of Economic Research.Google Scholar