This seems like pretty strong evidence that Social Security benefits — a mandatory government annuity — are far too generous. If that weren’t so, then seniors would supplement Social Security by purchasing additional annuities from their savings. Apparently, the vast majority, if given the choice, would rather have less Social Security and keep the tax savings unannuitized.
If you believe that the annuities market works and that households are rational in choosing not to use them, then this analysis is correct. Instead, some economists believe that the annuity market fails because people have too much private information about their own longevity (of course, if that is true, then the life insurance market also should fail). And, as the original post pointed out, many economists believe that households only fail to annuitize because of irrationality. My views to the contrary are not widely shared.
As I am making my own retirement plans I looked hard at annuities. Since I will already get Social security and a couple of small retirement checks it didn’t make a lot of sense to convert my IRA from stocks and bonds into annuities. A mix appears to work well. The annuities market is working just fine for me.
If people have lots of private information about longevity, then does political support for Social Security break down roughly along expected longevity? For example, do libertarians have lower life expectancy than democratic socialists? Not that I’m aware of.
If households and voters are irrational, then why would we expect our political system to produce the right level of Social Security? What is the explanation for why irrational voters acting through the political system to spend Other People’s money for Social Security benefits for yet still Other People choose more optimal benefit levels than when individuals make those decisions for themselves?
Annuities are a hedge against the risk of unexpectedly long life, but the average life expectancy of a financial services company isn’t all that long. Twenty years ago, Bear Stearns looked like one of the best possible counterparties to an annuity transaction, but they went bust in 2008. The government is probably the best possible counterparty to an annuity transaction- it’s likely to outlast you, and if it doesn’t you’re in a situation where contractual rights wouldn’t have helped you anyway.
When thinking about why Social Security passed, it is important to remember that it happened in 1935 several years after investments hit rock bottom. The depths of Great Depression are still incomprehensible to anybody under 80.
The other difference of Social Security and annuity sales, is I bet 40 – 50% of the population don’t have enough liquid savings for annuity. (And we have a economic system that has many middle class citizen biggest investment is their homeowner.)
A major reason for Social Security at the time was to encourage retirement. Unemployment was very high and removing laborers from the market was considered desirable. That’s less relevant right now.
I agree that a significant fraction of the population has little to no retirement savings, even into their 60s, and that fraction is unlikely to purchase annuities for roughly the same reason that they are unlikely to purchase private jets.
1. Opaque pricing. What’s the bid-offer spread between the two sides — life insurance and annuities (=longevity insurance)? It’s not transparent, but my gut feeling is that it’s very wide.
2. State insurance commissioners are very poor regulators (since the human capital is sucked into the private financial sector). Would you trust an insurance Co with your livelihood 20yrs from now?
I did the calculations to compare my 401k and an annuity. I would have to live longer than 92 for the annuity (under conservative stock market returns) to come out ahead. Of course if stocks crash for 20 yrs I lose this bet.