Arie Kapteyn (RAND)

“Do Consumers Know How to Value Annuities? Complexity as a Barrier to Annuitization”

abstract

This paper provides evidence that complexity of the annuitization decision process – rather than a preference for lump-sums –may help explain observed low levels of annuity purchases. We test this using Social Security benefits as our choice setting in an experimental module of the RAND American Life Panel. Although average annuity valuations under some elicitation methods are quite close to actuarial values, these averages mask notable heterogeneity in responses, including substantial numbers of respondents who provide responses that are hard to reconcilewith reasonable parameter assumptions. Strikingly, we also find that responses to willingness-to-pay versus willingness-to-accept are negatively correlated.  Financially literate consumers are better able to offer responses that are consistent across alternative ways of eliciting preferences for annuitization, though even for them it is difficult to explain much of the observed cross-sectional variation in annuity demand. Our results raise doubts about whether consumers can make utility-maximizing choices when confronted with the decision about whether to buy annuities in the real-world context.  Accordingly, observers should be cautious using observed demand for annuities to draw conclusions about the welfare consequences of annuitization.