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Purchasing an Annuity: Now or Later? The Role of Interest Rates

Author

Listed:
  • Thijs Markwat

    (Robeco Asset Management)

  • Roderick Molenaar

    (Robeco Asset Management)

  • Juan Carlos Rodriguez

    (Tilburg University)

Abstract

This paper investigates whether the option to delay annuitization in times of low interest rates has value for retirees. The retiree who chooses to wait bets on a fall in the annuity price brought about by a rise in the interest rates; the cost of such a bet is the loss of the mortality credit during the waiting period. We show that an investor who can only invest in bonds during the waiting period will never find waiting ex-ante profitable if annuities are fairly priced, because waiting is costly and buying a fairly priced annuity is a zero-npv project. In contrast, an investor allowed to invest part of her wealth in the stock market will be able to attain more consumption on average, but at the cost of a sharp increase in risk. A retiree may choose to wait, however, if she believes her views are not priced in the term structure. For such a retiree, waiting is optimal if the expected increase in the interest rate is larger than the square of the hazard rate.

Suggested Citation

  • Thijs Markwat & Roderick Molenaar & Juan Carlos Rodriguez, 2016. "Purchasing an Annuity: Now or Later? The Role of Interest Rates," Bankers, Markets & Investors, ESKA Publishing, issue 142, pages 4-17, May-June.
    • Handle: RePEc:rbq:journl:i:142:p:4-17
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    Keywords

    Annuities; Interest Rates; Financial Crises;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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