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SOCIAL SCIENCE RESEARCH NETWORK

E M P L O Y E E B E N E F I T S , C O M P E N S A T I O N
& P E N S I O N L A W
Vol. 7, No. 30: October 20, 2006

Editors: PAMELA J. PERUN
Urban Institute
PAMELA@PLANETNOW.COM
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Topic of This Issue:
Annuities
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T A B L E O F C O N T E N T S

"Efficient Annuitization with Delayed Payout Annuities"
JASON S. SCOTT
Financial Engines, Inc.
JOHN G. WATSON
Financial Engines, Inc.
WEI-YIN HU
Financial Engines, Inc.

"Heterogeneity in Survival Models - Applications to Pensions and
Life Annuities"
ANNAMARIA OLIVIERI
University of Parma - Facoltà di Economia

"Financial Innovation for an Aging World"
OLIVIA S. MITCHELL
University of Pennsylvania - Insurance & Risk Management
Department, National Bureau of Economic Research (NBER)
MICHAEL SHERRIS
School of Actuarial Studies
SHAUN YOW
University of New South Wales

"Asset Allocation and Annuity-Purchase Strategies to Minimize the
Probability of Financial Ruin"
MOSHE ARYE MILEVSKY
York University
KRISTEN MOORE
Affiliation Unknown

"Consumption Over the Life Cycle: The Role of Annuities"
GARY D. HANSEN
University of California, Los Angeles - Department of
Economics, National Bureau of Economic Research (NBER)
SELAHATTIN IMROHOROGLU
University of Southern California - Department of
Finance and Business Economics

"Portfolio Management and Retirement: What is the Best
Arrangement for a Family?"
THOMAS POST
Humboldt University of Berlin - School of Business and
Economics
HELMUT GRÜNDL
Humboldt University of Berlin - Faculty of Business
HATO ALBERT THOMAS VALENTIN SCHMEISER
University of St. Gallen
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"Efficient Annuitization with Delayed Payout Annuities"

Contact: JASON S. SCOTT
Financial Engines, Inc.
Email: jscott@financialengines.com
Auth-Page: http://ssrn.com/author=666589

Co-Author: JOHN G. WATSON
Financial Engines, Inc.
Email: jwatson@financialengines.com
Auth-Page: http://ssrn.com/author=681679

Co-Author: WEI-YIN HU
Financial Engines, Inc.
Email: whu@financialengines.com
Auth-Page: http://ssrn.com/author=504416

Full Text: http://ssrn.com/abstract=932145

ABSTRACT: Contrary to economic theory, few retirees voluntarily
annuitize much, if any, of their wealth. This behavior has been
at least partly explained by factors such as bequest motives, a
demand for liquid wealth, or a restrictive annuity investment
universe, all of which impose implicit costs on annuitization.
When such costs are considered, utility maximization implies a
preference for annuity contracts that are efficient in the sense
that they deliver maximum benefit for a given annuity investment.
In a standard lifecycle setting, we find that efficient annuity
allocations involve no annuity payouts in early years, while
later years are fully funded by annuities. Importantly, insurance
companies have recently introduced annuity contracts with payouts
that begin in the future, referred to as "delayed payout
annuities". We find that delayed payout annuities are highly
efficient. For a typical example, half the potential annuity
welfare gains require only a six percent allocation to delayed
payout annuities compared to a thirty-nine percent allocation to
immediate annuities. Because of their efficiency, delayed payout
annuities can substantially improve welfare, particularly for
retirees unwilling to annuitize large fractions of their wealth.
______________________________

"Heterogeneity in Survival Models - Applications to Pensions and
Life Annuities"

Contact: ANNAMARIA OLIVIERI
University of Parma - Facoltà di Economia
Email: annamaria.olivieri@unipr.it
Auth-Page: http://ssrn.com/author=456913

Full Text: http://ssrn.com/abstract=913770

ABSTRACT: The aim of this paper is to give an overview of the
models used to represent heterogeneity in life insurance, with
particular regard to pensions and life annuities.

First, heterogeneity due to risk factors observable at policy
issue is considered. The underwriting process addresses at least
some of these items, so that each contract can be assigned a
premium rate consistent with its specific features. Heterogeneity
models suitable to this regard can be looked at as individual
valuation models.

Secondly, we focus on heterogeneity due to unobservable risk
factors. These aspects, which usually are not embedded into the
underwriting process, require collective valuation models.

Whilst individual heterogeneity models are well known in life
insurance mathematics, collective models are not common. So the
paper is in particular devoted to the latter. Their actuarial
relevance is shown with some investigations concerning the life
annuity business, where due to evolving mortality a more detailed
representation of insured risks is recommended, so to reduce the
possibility of biased valuations.
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"Financial Innovation for an Aging World"
NBER Working Paper No. W12444

Contact: OLIVIA S. MITCHELL
University of Pennsylvania - Insurance & Risk
Management Department, National Bureau of Economic
Research (NBER)
Email: mitchelo@wharton.upenn.edu
Auth-Page: http://ssrn.com/author=41556

Co-Author: MICHAEL SHERRIS
School of Actuarial Studies
Email: m.sherris@unsw.edu.au
Auth-Page: http://ssrn.com/author=410919

Co-Author: SHAUN YOW
University of New South Wales
Email: shaun.yow@student.unsw.edu.au
Auth-Page: http://ssrn.com/author=655862

Full Text: http://ssrn.com/abstract=923971

ABSTRACT: Over the last half-century, around the world, many
nations have seen plummeting fertility rates and mounting life
expectancies. These two factors are the engine behind
unprecedented global aging. In this paper, we explore how the
demographic transition may influence financial markets and, in
turn, how financial market innovation might help resolve concerns
flowing from global aging trends. We first provide context by
reviewing the economics, finance, and insurance-related
literature on how global aging patterns may influence capital
markets. We then turn to insurance markets, and discuss a range
of products and policies, including both retail and wholesale
financial offerings for various forms of life annuities,
long-term care benefits, reverse mortgages, securitization of
longevity risk, inflation-protected assets, reinsurance,
guarantees, derivative contracts on residential property price
indices, mortality swaps and longevity derivative contracts. We
also indicate how new public-private partnerships might be
beneficial in enhancing the future environment for old-age risk
management.
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"Asset Allocation and Annuity-Purchase Strategies to Minimize the
Probability of Financial Ruin"
Mathematical Finance, Vol. 16, No. 4, pp. 647-671, October
2006

Contact: MOSHE ARYE MILEVSKY
York University
Email: milevsky@yorku.ca
Auth-Page: http://ssrn.com/author=1080

Co-Author: KRISTEN MOORE
Affiliation Unknown
Auth-Page: http://ssrn.com/author=667497

Full Text: http://ssrn.com/abstract=927845

ABSTRACT: In this paper, we derive the optimal investment and
annuitization strategies for a retiree whose objective is to
minimize the probability of lifetime ruin, namely the probability
that a fixed consumption strategy will lead to zero wealth while
the individual is still alive. Recent papers in the insurance
economics literature have examined utility-maximizing
annuitization strategies. Others in the probability, finance, and
risk management literature have derived shortfall-minimizing
investment and hedging strategies given a limited amount of
initial capital. This paper brings the two strands of research
together. Our model pre-supposes a retiree who does not currently
have sufficient wealth to purchase a life annuity that will yield
her exogenously desired fixed consumption level. She seeks the
asset allocation and annuitization strategy that will minimize
the probability of lifetime ruin. We demonstrate that because of
the binary nature of the investor's goal, she will not annuitize
any of her wealth until she can fully cover her desired
consumption with a life annuity. We derive a variational
inequality that governs the ruin probability and the optimal
strategies, and we demonstrate that the problem can be recast as
a related optimal stopping problem which yields a free-boundary
problem that is more tractable. We numerically calculate the ruin
probability and optimal strategies and examine how they change as
we vary the mortality assumption and parameters of the financial
model. Moreover, for the special case of exponential future
lifetime, we solve the (dual) problem explicitly. As a byproduct
of our calculations, we are able to quantify the reduction in
lifetime ruin probability that comes from being able to manage
the investment portfolio dynamically and purchase annuities.
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"Consumption Over the Life Cycle: The Role of Annuities"
NBER Working Paper No. W12341

Contact: GARY D. HANSEN
University of California, Los Angeles - Department
of Economics, National Bureau of Economic Research
(NBER)
Email: ghansen@econ.ucla.edu
Auth-Page: http://ssrn.com/author=55738

Co-Author: SELAHATTIN IMROHOROGLU
University of Southern California - Department of
Finance and Business Economics
Email: selo@marshall.usc.edu
Auth-Page: http://ssrn.com/author=89574

Full Text: http://ssrn.com/abstract=912451

ABSTRACT: We explore the quantitative implications of uncertainty
about the length of life and a lack of annuity markets for life
cycle consumption in a general equilibrium overlapping
generations model in which markets are otherwise complete.
Empirical studies find that consumption tends to rise early in
life, peak around age 45-55, and to decline after that. Our
calibrated model exhibits life cycle consumption that is
consistent with this pattern. This follows from the fact that,
due to a lack of annuity markets, households discount the future
more heavily as they age and their probability of survival falls.
Once an unfunded social security system is introduced, the
profile is still hump shaped, but the decline in consumption does
not begin until after retirement in our base case. Adding a
bequest motive causes this decline to begin at a younger age.
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"Portfolio Management and Retirement: What is the Best
Arrangement for a Family?"
Financial Markets and Portfolio Management, Vol. 20, No. 1,
pp. 265-285, 2006

Contact: THOMAS POST
Humboldt University of Berlin - School of Business
and Economics
Email: tpost@wiwi.hu-berlin.de
Auth-Page: http://ssrn.com/author=483512

Co-Author: HELMUT GRÜNDL
Humboldt University of Berlin - Faculty of Business
Email: gruendl@wiwi.hu-berlin.de
Auth-Page: http://ssrn.com/author=327305

Co-Author: HATO ALBERT THOMAS VALENTIN SCHMEISER
University of St. Gallen
Email: hato.schmeiser@unisg.ch
Auth-Page: http://ssrn.com/author=655821

Abstract: http://ssrn.com/abstract=930580

ABSTRACT: In comparing an immediate life annuity with a
payout-equivalent investment fund payout plan
(self-annuitization), research to date has focused mainly on
shortfall probabilities of self-annuitization. As an exception,
Schmeiser and Post (2005) propose a family strategy where the
chances of self-annuitization (i.e., bequests) are taken into
consideration as well. In such a family strategy, potential heirs
must bear shortfall risks, but in return have a chance of
receiving a bequest. This paper analyzes under which conditions
heirs will be willing to agree to a family strategy. The idea of
a family strategy is integrated into a realistically calibrated
intertemporal expected utility framework, taking into account
risks arising from stochastic life span, asset returns, and
nontradable labor income. A family strategy is shown to be
accepted for many parameter combinations, especially in
familieswith low marginal tax rates, if the heirs are wealthy, or
in a case where the retiree has an average population life
expectancy. We also work out how family self-annuitization
decisions interact with asset allocation, saving decisions, and
labor income risk. Under realistic conditions our results support
two explanations for the empirically observable low demand for
annuities (the so-called annuity puzzle), namely intra-family
risk sharing and high cost of market-annuitization.
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S O L I C I T A T I O N O F A B S T R A C T S

Employee Benefits, Compensation and Pension Law Abstracts is
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