Portfolio decisions on life annuities and financial assets with longevity and income uncertainty

There are two stylised facts, namely weak demand for life-annuities and flat age-wealth profile that contradict the life-cycle hypothesis. In this paper we design a theoretical framework, which combines plausible arguments, which have been put forward in the literature to reconcile theory with empirical evidence. Besides the existence of an annuity market and of a public pension system we assume risk-averse individuals who are uncertain about lifetime and disposable income and who have preferences for leaving bequests. It is shown that this framework can contribute to explain the observed portfolio decision in favour of financial assets relatively to annuities.savings; life annuities; bequests; uncertain lifetime; uncertain income; social security

Tax incentives for private life annuities and the social security reform: Effects on consumption and on adverse selection

In this paper we analyse several measures which are typically included in a social security reform: a cut in the social security benefits, an increase in the social security tax and tax incentives for the purchase of private life annuities, which have recently become quite popular at the political level. In a two-period model with uncertainty about life-expectancy, it is shown that for a given annuity price tax incentives for life annuities increases consumption expenditures in old-age, while the opposite occurs by a cut in the social security benefits and by an increase of the social security tax. The main result is that a tax incentive for life annuities and a cut in the social security benefits alleviate adverse selection in the private annuity market, while an increase in the social security tax exacerbates adverse selection.annuity market; uncertain lifetime; adverse selection; tax incentives; social security

Adverse Selection with individual- and joint-life annuities

This paper includes couples on the demand side and analyses their implications on the problem of adverse selection in the annuity market. First, we examine the pooling equilibrium for individual-life annuities and show that in the presence of couples the rate of return on individuallife annuities is lower in case that couples do not have the advantage of joint consumption of "family public goods" as well as in case of a logarithmic utility function. Second, we examine the market for joint-life annuities. Due to their higher chance that only one partner survives to the retirement, couples with short-lived partners put more weight on the survivor benefit than couples with at least one longer-lived partner. This fact is used by annuity companies to separate couples according to their partners' life-expectancies. Hence, we find that only a separating equilibrium may exist. These results are obtained in a framework where couples are mandated to buy joint-life annuities and only single persons buy individual-life annuities. When relaxing this assumption by allowing couples to choose between individual- and joint-life annuities, we find that in equilibrium couples with long-lived partners buy individual-life annuities, while couples with short-lived partners buy joint-life annuities. However, couples with one long-lived and one short-lived partner may decide for either type of annuities, depending on the exogenous parameters. Accordingly, we identify two different types of equilibria.annuity market; uncertain lifetime; adverse selection; equilibrium

Optimum taxation of inheritances

We incorporate the fact that inheritances create a second distinguishing characteristic of individuals, in addition to earning abilities, into an optimum income taxation model with bequests motivated by joy of giving. We show that a tax on inheritances and a uniform tax on all expenditures including bequests are equivalent and that either is desirable, according to an intertemporal social objective, if on average high-able individuals have larger inherited endowments than low-able. We demonstrate that such a situation results as the outcome of a process with stochastic transition of abilities over generations, if all descendants are more probable to have their parent’s ability rank than any other.inheritance tax

Optimum Taxation of Life Annuities

The market for private life annuities is characterised by adverse selection, that is, contracts offer lower than fair payoffs to individuals with low life expectancy. Moreover, life expectancy and income have been found to be positively correlated. The paper shows that a linear tax on annuity payoffs, which raises more revenues from long-living individuals than from short-living, represents an appropriate instrument for redistribution, in addition to an optimally designed labour income tax. Further, we find that a nonlinear tax on annuity payoffs can be directly employed to correct the distortion of the rate of return caused by asymmetric information. These results are contrasted with theoretical findings concerning the role of a tax on capital income.Optimum taxation; life annuities; adverse selection

Optimum taxation of bequests in a model with initial wealth

We formulate an optimum-taxation model, where parents leave bequests to their descendants for altruistic reasons. In contrast to the standard model, individuals differ not only in earning abilities, but also ininitial (inherited) wealth. In this model a redistributive motive for an inheritance tax - which is equivalent to a uniform tax on all expenditures - arises, given that initial wealth increases with earning abilities. Its introduction increases intertemporal social welfare or has an ambiguous effect, depending on whether the bequeathing generation can adjust their behaviour and whether the external effect related to altruism is accounted for in the social objective.

Adverse selection in the annuity market when payoffs vary over the time of retirement

This paper investigates the effect of adverse selection and price competition on the private annuity market in a model with two retirement periods. In this framework annuity companies can offer contracts with different payoffs over the periods of retirement. Varying the time structure of the payoffs affects annuity demand and welfare of individuals with low and high life expectancy in different ways. By this, annuity purchasers can be separated according to their survival probabilities. Our main finding is that a Nash-Cournot equilibrium may not exist; if one exists, it will be a separating equilibrium. On the other hand, even if a separating equilibrium does not exist, a Wilson pooling equilibrium exists.annuity markets; adverse selection; uncertain lifetimes; pooling equilibrium; separating equilibrium.

Adverse Selection in the Annuity Market with Sequential and Simultaneous Insurance Demand

This paper investigates the effect of adverse selection on the private annuity market in a model with two periods of retirement. In order to introduce the existence of limited-time pension insurance, we assume that for each period of retirement separate contracts can be purchased. Demand for the two periods can be decided either sequentially or simultaneously. We show that different risk-groups prefer different types of contracts, and that only the sequential contracts, which are favourable for the long-living individuals, represent an equilibrium.annuity markets, adverse selection, uncertain lifetimes, equilibrium

Adverse selection in the annuity market with sequential and simultaneous insurance demand

This paper investigates the effect of adverse selection on the private annuity market in a model with two periods of retirement. In order to introduce the existence of limited-time pension insurance, we assume that for each period of retirement separate contracts can be purchased. Demand for the two periods can be decided either sequentially or simultaneously. We show that different risk-groups prefer different types of contracts, and that only the sequential contracts, which are favourable for the long-living individuals, represent an equilibrium.annuity markets; adverse selection; uncertain lifetimes; equilibrium

Optimum Taxation of Bequests in a Model with Initial Wealth

We formulate an optimum-taxation model, where parents leave bequests to their descendants for altruistic reasons. In contrast to the standard model, individuals differ not only in earning abilities, but also in initial (inherited) wealth. In this model a redistributive motive for an inheritance tax - which is equivalent to a uniform tax on all expenditures - arises, given that initial wealth increases with earning abilities. Its introduction increases intertemporal social welfare or has an ambiguous effect, depending on whether the bequeathing generation can adjust their behaviour and whether the external effect related to altruism is accounted for in the social objective.optimum taxation, taxation of bequests