Health cost risk

A potential solution to the annuity puzzle

J.M.J. Peijnenburg, Theo Nijman, Bas Werker

Research output: Contribution to journalArticleScientificpeer-review

178 Downloads (Pure)

Abstract

We find that health cost risk lowers optimal annuity demand at retirement. If medical expenses can be sizeable early in retirement, full annuitisation at retirement is no longer optimal because agents do not have enough time to build a liquid wealth buffer. Furthermore, large deviations from optimal annuitisation levels lead to small utility differences. Our results suggest that health cost risk can explain a large proportion of empirically observed annuity choices. Finally, allowing additional annuitisation after retirement results in welfare gains of at most 2.5% when facing health cost risk, and negligible gains without this risk.
Original languageEnglish
Pages (from-to)1598-1625
JournalThe Economic Journal
Volume127
Issue number603
DOIs
Publication statusPublished - Aug 2017

Fingerprint

Retirement
Annuities
Health costs
Annuitization
Time to build
Wealth
Expenses
Welfare gains
Proportion
Buffer
Large deviations

Keywords

  • Life-cycle portfolio choice
  • retirement
  • post-retirement investment

Cite this

@article{257e76c954bb4103bd2695d15a6141f0,
title = "Health cost risk: A potential solution to the annuity puzzle",
abstract = "We find that health cost risk lowers optimal annuity demand at retirement. If medical expenses can be sizeable early in retirement, full annuitisation at retirement is no longer optimal because agents do not have enough time to build a liquid wealth buffer. Furthermore, large deviations from optimal annuitisation levels lead to small utility differences. Our results suggest that health cost risk can explain a large proportion of empirically observed annuity choices. Finally, allowing additional annuitisation after retirement results in welfare gains of at most 2.5{\%} when facing health cost risk, and negligible gains without this risk.",
keywords = "Life-cycle portfolio choice, retirement, post-retirement investment",
author = "J.M.J. Peijnenburg and Theo Nijman and Bas Werker",
year = "2017",
month = "8",
doi = "10.1111/ecoj.12354",
language = "English",
volume = "127",
pages = "1598--1625",
journal = "The Economic Journal",
issn = "0013-0133",
publisher = "Wiley-Blackwell",
number = "603",

}

Health cost risk : A potential solution to the annuity puzzle. / Peijnenburg, J.M.J.; Nijman, Theo; Werker, Bas.

In: The Economic Journal, Vol. 127, No. 603, 08.2017, p. 1598-1625.

Research output: Contribution to journalArticleScientificpeer-review

TY - JOUR

T1 - Health cost risk

T2 - A potential solution to the annuity puzzle

AU - Peijnenburg, J.M.J.

AU - Nijman, Theo

AU - Werker, Bas

PY - 2017/8

Y1 - 2017/8

N2 - We find that health cost risk lowers optimal annuity demand at retirement. If medical expenses can be sizeable early in retirement, full annuitisation at retirement is no longer optimal because agents do not have enough time to build a liquid wealth buffer. Furthermore, large deviations from optimal annuitisation levels lead to small utility differences. Our results suggest that health cost risk can explain a large proportion of empirically observed annuity choices. Finally, allowing additional annuitisation after retirement results in welfare gains of at most 2.5% when facing health cost risk, and negligible gains without this risk.

AB - We find that health cost risk lowers optimal annuity demand at retirement. If medical expenses can be sizeable early in retirement, full annuitisation at retirement is no longer optimal because agents do not have enough time to build a liquid wealth buffer. Furthermore, large deviations from optimal annuitisation levels lead to small utility differences. Our results suggest that health cost risk can explain a large proportion of empirically observed annuity choices. Finally, allowing additional annuitisation after retirement results in welfare gains of at most 2.5% when facing health cost risk, and negligible gains without this risk.

KW - Life-cycle portfolio choice

KW - retirement

KW - post-retirement investment

U2 - 10.1111/ecoj.12354

DO - 10.1111/ecoj.12354

M3 - Article

VL - 127

SP - 1598

EP - 1625

JO - The Economic Journal

JF - The Economic Journal

SN - 0013-0133

IS - 603

ER -