The Cost of Annuities: Implications for Saving Behavior and Bequests

The fact that most eldealy individuals in the United States choose to maintain a flat age-wealth profile, rather than buy individual life annuities, stands in contrast to central implications of the standard life-cycle model of consumption-saving behavior. The analysis in this paper lends support to an explanation for this phenomenon based either on the cost of annuities, importantly including the element of that cost due to adverse selection, or on the interaction of that cost and an intentional bequest motive. Expected yields offered on individual life annuities in the United States are lower by some 4-6%, or 2 1/2-4 1/2% after allowing for adverse selection, than yields on alternative long-term fixed-income investments. Simulations of an extended model of life-cycle saving and portfolio behavior, allowing explicitly for uncertain lifetimes and Social Security, show that yield differentials in this range can account for the observed behavior, even in the absence of a bequest motive, during the early years of retirement. By contrast, at older ages the combination of yield differentials in this range and a positive bequest motive is necessary to do so.

Annuity Prices and Saving Behavior in the United States

The observed reluctance of most individuals in the United States to buy individual life annuities, and the concomitant approximately flat average age-wealth profile, stand in sharp contradiction to the standard life cycle model of consumption-saving behavior. The analysis in this paper lends support to an explanation for this phenomenon based on the interaction of an intentional bequest motive and annuity prices that are not actuarially fair. Premiums charged for individual life annuities in the United States include a load factor of 32-48c per dollar,or18-33c per dollar after allowing for adverse selection, in comparison to actuarially fair annuity values. Load factors of this size are not out of line with those on other familiar (and almost universally purchased) insurance products. Simulations of an extended model of life cycle saving and portfolio behavior, allowing explicitly for uncertain lifetimes and Social Security, show that the load factor charged would have to be far larger than this to account for the observed behavior in the absence of a bequest motive. By contrast, the combination of a load factor in this range and a positive bequest motive can do so for some plausible values of the assumed underlying parameters. Moreover,if this combination of factors is leading elderly individuals to avoid purchasing life annuities, it implies a typical bequest that is fairly large in comparison to their consumption.

Specification of the Joy of Giving: Insights from Altruism

This paper analyzes the joy of giving bequest motive in which the utility obtained from leaving a bequest depends only on the size of the bequest. It exploits the fact that this formulation can be interpreted as a reduced form of an altruistic bequest motive to derive a relation between the value of the altruism parameter and the value of the joy of giving parameter. Using previous discussions of an a priori range of plausible values for the altruism parameter we then derive plausible restrictions on the joy of giving parameter. We demonstrate that this parameter may well be orders of magnitude larger than assumed in the existing literature.

Life Insurance Savings and the After-Tax Life Insurance Rate of Return

This paper presents a calculation of the time series of the after-tax rate of return to whole life insurancy. When compared to the after-tax return on an alternative portfolio of similar risk, more than 60%of the decline in life insurance savings (suitably defined) in the past two decades can be attributed to a widening after-tax rate of return differen-tial.Both the existence and importance of this result depend on the characteristics of life insurance savings. Life insurance saving is intimately connected to life insurance coverage and therefore is long-term and quasi-contractual in nature. Furthermore (and, in part, because of the above characteristics), the interest earned on the fixed income portfolio of life insurance intermediaries has been taxed under a special set of rules. From 1958 to 1981,these rules have taken the rather complicated form of the Menge formula. This formula is very sensitive to changes in nominal interest rate levels and in particular, during inflationary periods it acts so as to dramatically increase the tax burden of life insurancesavings.Life insurance savings is therefore an example of the non-neutrality of monetary policy. This is important for studies of flow of funds and capital accumulation using the historical record.

Defined Benefit Pension Plans and the Financial Crisis: Impact and Sponsors and Government Reactions

The global financial crisis of 2008-9 hit corporate defined benefit (DB) plans just as the new funding and other provisions of the Pension Protection Act of 2006 were being implemented. Both sponsors and the federal government reacted to the large shortfalls that developed. In this paper, the impacts and reactions are documented and the implications are evaluated. In particular, plans’ funding status dropped dramatically, sponsors reduced risk in investments, increased contributions, and changed plan design, while premiums paid to the PBGC nearly doubled, and the federal government, through regulations and legislation, provided some temporary and/or conditional funding relief. Because the relief is temporary, and discount rates are projected to remain low, the shortfalls largely remain, dependent on future developments in financial markets. For the longer-term, the heightened appreciation for risk, as affecting both DB and defined contribution plans, has led to proposals for a new, more flexible, DB-like plan type called the flexible structured plan and other changes in government policies

The New Pension Law and Defined Benefit Plans: A Surprisingly Good Match

Much of the commentary on the new pension reform law suggests that it will be deleterious to defined benefit plans. We describe the economic policy background leading to the new law, the law’s main funding provisions, and analyze the volatility of required minimum contributions, leading us to the opposite conclusion. The new law should improve benefit security, reduce contribution volatility, and encourage responsible management and creative plan design, thereby improving the environment in which defined benefit plans are sponsored by employers and retirement benefits are earned by workers

Life-cycle saving, limits on contributions to DC pension plans, and lifetime tax benefits

This paper analyzes questions related to defined contribution (DC) plans. For what types of households are statutory contribution limits likely to bind? How large is the lifetime tax benefit from participating in a DC plan and how does it vary with lifetime income? The authors find that contribution limits bind for households that begin their plan participation late in life or wish to retire early, single-earner households, those who are not borrowing-constrained, those with rapid rates of real wage growth, and those with high levels of earnings regardless of age. Setting contribution rates at the average maximum level allowed by employers and assuming a 4% real return on assets, the lifetime benefit rises from 2% of lifetime consumption for households earning $25,000 per year, to 9.8$300,000 per year. Contribution ceilings limit the benefit for high earners and are sensitive to the assumed rate of return.Saving and investment ; Retirement