According to standard economic models, a risk-averse consumer who does not know how long he will live should place a high value on life annuities that provide guaranteed income for life. Yet numerous studies show that few consumers voluntarily annuitize their retirement savings. Rather than attempting to rationalize the lack of annuity demand, this paper explores the idea that aversion to annuities is not a fully rational phenomenon. This paper suggests that a psychologically richer model of consumer behavior can explain under-annuitization. We hypothesize that framing matters for annuitization decisions: when consumers think in terms of consumption, annuities are viewed as valuable insurance, whereas when consumers think in terms of investment risk and return, the annuity is a risky asset because the payoff depends on an uncertain date of death. Survey evidence is consistent with our hypothesis that framing matters: the vast majority of individuals prefer an annuity over alternative products when the question is framed in terms of consumption, while the majority of individuals prefer non-annuitized products when the questions are presented in terms of risk and return.
This paper was featured in an article in
March 1, 2008.