Cognitive Constraints on Valuing Annuities

This paper documents consumers’ difficulty valuing life annuities. Using a purpose-built experiment in the American Life Panel, we show that the prices at which people are willing to buy annuities are substantially below the prices at which they are willing to sell them. We also find that buy values are negatively correlated with sell values and that the sell-buy valuation spread is negatively correlated with cognition. This spread is larger for those with less education, weaker numerical abilities, and lower levels of financial literacy. Our evidence contributes to the emerging literature on heterogeneity in financial decision-making abilities, particularly regarding retirement payouts

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

This paper provides experimental evidence that individuals have difficulty valuing annuities, and this difficulty – rather than a preference for lump sums – can help explain observed low levels of annuity purchases. Although the median price at which people are willing to sell an annuity is close to median actuarial values, this masks notable heterogeneity in responses including substantial numbers of respondents whose responses are difficult to reconcile with optimizing behavior under any reasonable parameter assumptions. We also discover that people are willing to pay substantially less to buy a larger annuity, a result not due to liquidity constraints or endowment effects. Strikingly, we also learn that individual responses to the buy versus sell decisions are negatively correlated, an effect that is stronger for the less financially sophisticated. Our findings are consistent with boundedly rational consumers who adopt a “buy low, sell high” heuristic when faced with a complex trade-off. Moreover, at the margin, subjective valuations vary nearly one-for-one with actuarial values but are uncorrelated with utility-based measures designed to measure the insurance value of annuities. This supports the hypothesis that people use simplifying heuristics to think about annuities, rather than engaging in optimizing behavior. Results also underscore the difficulty of explaining the cross-sectional variation in annuity valuations using standard empirical models. Our findings raise doubt about whether most consumers can make optimal decisions about annuitization

Behavioral Impediments to Valuing Annuities: Complexity and Choice Bracketing

This paper examines two behavioral factors that diminish people’s ability to value a lifetime income stream or annuity, drawing on a survey of about 4,000 adults in a U.S. nationally representative sample. By experimentally varying the degree of complexity, we provide the first causal evidence that increasing the complexity of the annuity choice reduces respondents’ ability to value the annuity, measured by the difference between the sell and buy values people assign to the annuity. We also find that people’s ability to value an annuity increases when we experimentally induce them to think jointly about the annuitization decision as well as how quickly or slowly to spend down assets in retirement. Accordingly, we conclude that narrow choice bracketing is an impediment to annuitization, yet this impediment can be mitigated with a relatively straightforward intervention

Nominal or Real? The Impact of Regional Price Levels on Satisfaction with Life

According to economic theory, real income, i.e., nominal income adjusted for purchasing power, should be the relevant source of life satisfaction. Previous work, however, has only studied the impact of inflation adjusted nominal income and not taken into account regional differences in purchasing power. Therefore, we use a novel data set to study how regional price levels affect satisfaction with life. The data set comprises about 7 million data points that are used to construct a price level for each of the 428 administrative districts in Germany. We estimate pooled OLS and ordered probit models that include a comprehensive set of individual level, time-varying and time-invariant control variables as well as control variables that capture district heterogeneity other than the price level. Our results show that higher price levels significantly reduce life satisfaction. Furthermore, we find that a higher price level tends to induce a larger loss in life satisfaction than a corresponding decrease in nominal income. A formal test of neutrality of money, however, does not reject neutrality of money. Our results provide an argument in favor of regional indexation of government transfer payments such as social welfare benefits

Who Needs Good Neighbours?

Abstract: Due to the increasing spatial dispersion of social networks, the association between neighbor relationships and quality of life has become more uncertain. Our analysis used instrumental variable modelling to reduce bias associated with residual confounding and reverse causation, in order to provide a more reliable examination of the effect of interaction with neighbors on subjective well-being than previous work. While the frames of reference for individuals’ socializing may have shifted outside the neighborhood, our analysis provides robust evidence that interaction with neighbors still matters a great deal for subjective well-being. A further important question to ask is if neighboring does affect well-being, then are there certain groups in society for whom contact with neighbors matters more? Our analysis suggests that there are, namely for those in a relationship, unemployed or retired. This means that while fostering contact with neighbors has the potential to significantly improve individual well-being, such policy efforts are likely to matter a good deal more in neighborhoods with relatively large numbers of geographically constrained social groups, such as the elderly and the unemployed. Key words: subjective well-being, neighborly interaction, social capita

Can a concern for status reconcile diverse social welfare programs?

Let there be two individuals: “rich,” and “poor.” Due to inefficiency of the income redistribution policy, if a social planner were to tax the rich in order to transfer to the poor, only a fraction of the taxed income would be given to the poor. Under such inefficiency and a standard utility specification, a Rawlsian social planner who seeks to maximize the utility of the worst-off individual will select a different allocation of incomes than a utilitarian social planner who seeks to maximize the sum of the individuals’ utilities. However, when individuals prefer not only to have more income but also not to have low status conceptualized as low relative income, and when this distaste is incorporated in the individuals’ utility functions with a weight that is greater than a specified critical level, then a utilitarian social planner will select the very same income distribution as a Rawlsian social planner

The impact of government policies on income inequality and the translation of growth into income poverty reduction: protocol for two systematic reviews

The eradication of poverty has been a central aim of international development for several decades, and the importance of reducing inequality is also increasingly accepted. This paper presents the protocols for two systematic reviews on the government policies and interventions that affect in-country income inequality and the translation of economic growth into reductions in income poverty. The paper describes the background to the reviews and the links between them, their aims and scope, the inclusion criteria, search strategy and synthesis options