Cover: Do Consumers Know How to Value Annuities?

Do Consumers Know How to Value Annuities?

Complexity as a Barrier to Annuitization

Published Mar 9, 2012

by Jeffrey R. Brown, Arie Kapteyn, Erzo F.P. Luttmer, Olivia Mitchell

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This paper suggests that many people find the annuitization decision complex, and that this complexity, rather than a taste for lump sums, may explain observed low levels of annuity purchases. Specifically, the authors find that consumers tend to value annuities less when given the opportunity to buy more, but value them more highly when given the opportunity to sell annuities in exchange for a lump sum. They further show that more financially literate consumers are better able to offer responses that are consistent across alternative ways of eliciting preferences for annuitization. These results raise doubts about whether consumers can make utility-maximizing choices when confronted with the decision about whether to buy an annuity in real-world situations. In addition, they suggest that observers should be very careful in drawing conclusions about individual welfare based on observed behavior when it comes to annuities and, possibly, other complex financial products such as long-term care insurance.

The research described in this working paper was prepared by RAND Labor and Population for the Social Security Administration Financial Literacy Research Consortium.

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