What Factors Can Explain Low Annuity Market Participation Rate Among U.S. Retirees?
This article evaluates different reasons why retirement savers in the United States do not buy private annuities. To illustrate this problem and to set the ground for subsequent discussion, the insight uses a simple example:
Suppose an individual has at most three years left to live. Moreover, every year he has a 20% probability of dying. In the first year he has $1,000. He can invest this in a regular bond; let us assume this bond will bring a return of 2%. That means that in the second period (year) this individual will have $1,020. He can keep $515 and reinvest the other $505 in a bond with the same rate of return, which will bring him $515 in the third year. Thus, his income flow will be $515 per year. Suppose, instead, he invests in an actuarially fair annuity. This annuity will convert the retirement saver’s $1,000 into income of $714, which is substantially higher than the $515 per year obtained from bond investments.
Why then do so few people buy private annuities? The article considers seven possible explanations: bequest motive, adverse selection, medical expenses, minimum purchase requirement, illiquid housing wealth, government-provided means-tested transfers, and pre-annuitized wealth.