IDEAS home Printed from https://ideas.repec.org/a/eee/insuma/v90y2020icp94-104.html
   My bibliography  Save this article

Optimal allocation to Deferred Income Annuities

Author

Listed:
  • Habib, F.
  • Huang, H.
  • Mauskopf, A.
  • Nikolic, B.
  • Salisbury, T.S.

Abstract

In this paper we employ a lifecycle model that uses utility of consumption and bequest to determine an optimal Deferred Income Annuity (DIA) purchase policy. We lay out a mathematical framework to formalize the optimization process. The method and implementation of the optimization is explained, and the results are then analyzed. We extend our model to control for asset allocation and show how the purchase policy changes when one is allowed to vary asset allocation. Our results indicate that(i) refundable DIAs are less appealing than non-refundable DIAs because of the loss of mortality credits; (ii) the DIA allocation region is larger under the fixed asset allocation strategy due to it becoming a proxy for fixed-income allocation; and (iii) when the investor is allowed to change asset-allocation, DIA allocation becomes less appealing. However, a case for higher DIA allocation can be made for those individuals who perceive their longevity to be higher than the population.

Suggested Citation

  • Habib, F. & Huang, H. & Mauskopf, A. & Nikolic, B. & Salisbury, T.S., 2020. "Optimal allocation to Deferred Income Annuities," Insurance: Mathematics and Economics, Elsevier, vol. 90(C), pages 94-104.
    • Handle: RePEc:eee:insuma:v:90:y:2020:i:c:p:94-104
    DOI: 10.1016/j.insmatheco.2019.05.001
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0167668718304827
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.insmatheco.2019.05.001?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Hainaut, Donatien & Deelstra, Griselda, 2014. "Optimal timing for annuitization, based on jump diffusion fund and stochastic mortality," Journal of Economic Dynamics and Control, Elsevier, vol. 44(C), pages 124-146.
    2. Mankiw, N. Gregory & Zeldes, Stephen P., 1991. "The consumption of stockholders and nonstockholders," Journal of Financial Economics, Elsevier, vol. 29(1), pages 97-112, March.
    3. S. Browne & M. A. Milevsky & T. S. Salisbury, 2003. "Asset Allocation and the Liquidity Premium for Illiquid Annuities," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 70(3), pages 509-526, September.
    4. Moshe A. Milevsky & Kristen S. Moore & Virginia R. Young, 2006. "Asset Allocation And Annuity‐Purchase Strategies To Minimize The Probability Of Financial Ruin," Mathematical Finance, Wiley Blackwell, vol. 16(4), pages 647-671, October.
    5. Menahem E. Yaari, 1965. "Uncertain Lifetime, Life Insurance, and the Theory of the Consumer," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 32(2), pages 137-150.
    6. Martin Feldstein & Elena Ranguelova, 2001. "Individual Risk in an Investment-Based Social Security System," American Economic Review, American Economic Association, vol. 91(4), pages 1116-1125, September.
    7. Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, vol. 3(4), pages 373-413, December.
    8. Huaxiong Huang & Moshe A. Milevsky & Virginia R. Young, 2017. "Optimal Purchasing of Deferred Income Annuities When Payout Yields are Mean-Reverting," Review of Finance, European Finance Association, vol. 21(1), pages 327-361.
    9. Horneff, Wolfram J. & Maurer, Raimond H. & Mitchell, Olivia S. & Stamos, Michael Z., 2009. "Asset allocation and location over the life cycle with investment-linked survival-contingent payouts," Journal of Banking & Finance, Elsevier, vol. 33(9), pages 1688-1699, September.
    10. Milevsky, Moshe A. & Young, Virginia R., 2007. "Annuitization and asset allocation," Journal of Economic Dynamics and Control, Elsevier, vol. 31(9), pages 3138-3177, September.
    11. Ralph S. J. Koijen & Theo E. Nijman & Bas J. M. Werker, 2011. "Optimal Annuity Risk Management," Review of Finance, European Finance Association, vol. 15(4), pages 799-833.
    12. Campbell, John Y. & Viceira, Luis M., 2002. "Strategic Asset Allocation: Portfolio Choice for Long-Term Investors," OUP Catalogue, Oxford University Press, number 9780198296942.
    13. Milevsky,Moshe A., 2006. "The Calculus of Retirement Income," Cambridge Books, Cambridge University Press, number 9780521842587, October.
    14. Friend, Irwin & Blume, Marshall E, 1975. "The Demand for Risky Assets," American Economic Review, American Economic Association, vol. 65(5), pages 900-922, December.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Milevsky, Moshe A. & Salisbury, Thomas S., 2022. "Refundable income annuities: Feasibility of money-back guarantees," Insurance: Mathematics and Economics, Elsevier, vol. 105(C), pages 175-193.
    2. Butt, Adam & Khemka, Gaurav & Warren, Geoffrey J., 2022. "Heterogeneity in optimal investment and drawdown strategies in retirement," Pacific-Basin Finance Journal, Elsevier, vol. 74(C).
    3. David Blanchett & Branislav Nikolic, 2023. "Historical pricing variability in immediate and deferred income annuities," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 26(2), pages 271-280, July.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. F. Habib & H. Huang & A. Mauskopf & B. Nikolic & T. S. Salisbury, 2021. "Optimal allocation to deferred income annuities," Papers 2111.01234, arXiv.org.
    2. Blake, David & Wright, Douglas & Zhang, Yumeng, 2014. "Age-dependent investing: Optimal funding and investment strategies in defined contribution pension plans when members are rational life cycle financial planners," Journal of Economic Dynamics and Control, Elsevier, vol. 38(C), pages 105-124.
    3. Milevsky, Moshe A. & Young, Virginia R., 2007. "Annuitization and asset allocation," Journal of Economic Dynamics and Control, Elsevier, vol. 31(9), pages 3138-3177, September.
    4. Wolfram J. Horneff & Raimond H. Maurer & Olivia S. Mitchel & Michael Z. Stamos, 2008. "Asset Allocation and Location over the Life Cycle with Survival-Contingent Payouts," Working Papers wp177, University of Michigan, Michigan Retirement Research Center.
    5. Milevsky, Moshe A. & Salisbury, Thomas S., 2022. "Refundable income annuities: Feasibility of money-back guarantees," Insurance: Mathematics and Economics, Elsevier, vol. 105(C), pages 175-193.
    6. Kaschützke, B. & Maurer, R., 2016. "Investing and Portfolio Allocation for Retirement," Handbook of the Economics of Population Aging, in: Piggott, John & Woodland, Alan (ed.), Handbook of the Economics of Population Aging, edition 1, volume 1, chapter 0, pages 567-608, Elsevier.
    7. Horneff, Wolfram J. & Maurer, Raimond H. & Mitchell, Olivia S. & Stamos, Michael Z., 2010. "Variable payout annuities and dynamic portfolio choice in retirement," Journal of Pension Economics and Finance, Cambridge University Press, vol. 9(2), pages 163-183, April.
    8. Jingjing Chai & Wolfram Horneff & Raimond Maurer & Olivia S. Mitchell, 2011. "Optimal Portfolio Choice over the Life Cycle with Flexible Work, Endogenous Retirement, and Lifetime Payouts," Review of Finance, European Finance Association, vol. 15(4), pages 875-907.
    9. Sutcliffe, Charles, 2015. "Trading death: The implications of annuity replication for the annuity puzzle, arbitrage, speculation and portfolios," International Review of Financial Analysis, Elsevier, vol. 38(C), pages 163-174.
    10. Horneff, Wolfram J. & Maurer, Raimond H. & Mitchell, Olivia S. & Dus, Ivica, 2008. "Following the rules: Integrating asset allocation and annuitization in retirement portfolios," Insurance: Mathematics and Economics, Elsevier, vol. 42(1), pages 396-408, February.
    11. Narat Charupat & Mark J. Kamstra & Moshe A. Milevsky, 2016. "The Sluggish and Asymmetric Reaction of Life Annuity Prices to Changes in Interest Rates," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 83(3), pages 519-555, September.
    12. Owadally, Iqbal & Jang, Chul & Clare, Andrew, 2021. "Optimal investment for a retirement plan with deferred annuities," Insurance: Mathematics and Economics, Elsevier, vol. 98(C), pages 51-62.
    13. Horneff, Wolfram J. & Maurer, Raimond H. & Stamos, Michael Z., 2008. "Life-cycle asset allocation with annuity markets," Journal of Economic Dynamics and Control, Elsevier, vol. 32(11), pages 3590-3612, November.
    14. Horneff, Wolfram J. & Maurer, Raimond H. & Mitchell, Olivia S. & Stamos, Michael Z., 2009. "Asset allocation and location over the life cycle with investment-linked survival-contingent payouts," Journal of Banking & Finance, Elsevier, vol. 33(9), pages 1688-1699, September.
    15. Stamos, Michael Z., 2008. "Optimal consumption and portfolio choice for pooled annuity funds," Insurance: Mathematics and Economics, Elsevier, vol. 43(1), pages 56-68, August.
    16. Marina Di Giacinto & Bjarne Højgaard & Elena Vigna, 2010. "Optimal time of annuitization in the decumulation phase of a defined contribution pension scheme," Working Papers 2010-08, Universita' di Cassino, Dipartimento di Economia e Giurisprudenza.
    17. Francisco Gomes & Michael Haliassos & Tarun Ramadorai, 2021. "Household Finance," Journal of Economic Literature, American Economic Association, vol. 59(3), pages 919-1000, September.
    18. Horneff, Vanya & Maurer, Raimond & Mitchell, Olivia S. & Rogalla, Ralph, 2015. "Optimal life cycle portfolio choice with variable annuities offering liquidity and investment downside protection," Insurance: Mathematics and Economics, Elsevier, vol. 63(C), pages 91-107.
    19. Aparna Gupta & Zhisheng Li, 2013. "Optimal Annuity Purchase Decisions Under Uncertain Lifetime," Journal of Family and Economic Issues, Springer, vol. 34(4), pages 447-459, December.
    20. Wolfram J. Horneff & Raimond H. Maurer & Olivia S. Mitchell & Michael Z. Stamos, 2008. "Asset Allocation and Location over the Life Cycle with Survival-Contingent Payouts," NBER Working Papers 14055, National Bureau of Economic Research, Inc.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:insuma:v:90:y:2020:i:c:p:94-104. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/505554 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.