American Economic Review
ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)
Optimal Annuitization with Stochastic Mortality and Correlated Medical Costs
American Economic Review
vol. 105,
no. 11, November 2015
(pp. 3273–3320)
Abstract
The conventional wisdom since Yaari (1965) is that households without a bequest motive should fully annuitize their investments. Numerous frictions do not break this sharp result. We modify the Yaari framework by allowing a household's mortality risk itself to be stochastic due to health shocks. A lifetime annuity still helps to hedge longevity risk. But the annuity's remaining present value is correlated with medical costs, such as those for nursing home care, thereby reducing annuity demand, even without ad-hoc liquidity constraints. We find that most households should not hold a positive level of annuities, and many should hold negative amounts. (JEL D14, D82, G23, I12, J14, J26)Citation
Reichling, Felix, and Kent Smetters. 2015. "Optimal Annuitization with Stochastic Mortality and Correlated Medical Costs." American Economic Review, 105 (11): 3273–3320. DOI: 10.1257/aer.20131584Additional Materials
JEL Classification
- D14 Household Saving; Personal Finance
- D82 Asymmetric and Private Information; Mechanism Design
- G23 Pension Funds; Non-bank Financial Institutions; Financial Instruments; Institutional Investors
- I12 Health Behavior
- J14 Economics of the Elderly; Economics of the Handicapped; Non-labor Market Discrimination
- J26 Retirement; Retirement Policies