The Annuity Puzzle: Drivers of Annuitization Decisions, Behavioral Biases, and Potential Solutions to Under-Annuitization
In light of a growing elderly population in many countries, combined with an increasing life expectancy, annuities become increasingly important to avert old-age poverty by protecting people against longevity risk, or the risk of outliving their money. Life annuities insure against this risk by offering a lifelong guaranteed payment stream. However, despite the fact that early theoretical articles such as Menahem E. Yaari (1965) predict high annuitization rates, in the real world, people rarely choose to annuitize and annuitization rates remain on a low level; this situation is referred to as the annuity puzzle. This puzzle raises questions about relevant drivers of annuity demand, the role of behavioral biases, and solutions to potential under-annuitization.
To better understand the drivers of annuitization decisions, Maria Alexandrova and Nadine Gatzert collected theoretical, empirical, and experimental evidence from 89 research articles in their paper “What Do We Know about Annuitization Decisions?” Since the optimal annuitization decision also depends on other types of annuitization opportunities such as statutory pensions and other public transfers, the authors first discuss reasons and implications of mandatory annuitization. According to the majority of 13 articles on this issue, most of which are theoretical and a few empirical, mandatory annuitization is generally welfare-improving for society.