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Seminar II: Do Consumers Know How to Value Annuities? Complexity as a Barrier to Annuitization

Jeffrey Brown
University of Illinois' College of Business

Paper Abstract
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March 21, 2013
3:30 pm to 5:00 pm
Reception to follow

The George Washington University School of Business
Room 652, Duquès Hall
2201 G Street NW (22nd Street entrance)
Metro: Foggy Bottom Station

Biographical Statement: Jeffrey R. Brown

Jeffrey R. Brown is the William G. Karnes Professor of Finance and Director of the Center for Business and Public Policy at the University of Illinois' College of Business. He is a Research Associate of the National Bureau of Economic Research, where he also serves as Associate Director of the NBER Retirement Research Center and as Editor of the Tax Policy and the Economy series. Dr. Brown earned his B.A. from Miami University (Ohio), his M.P.P. from Harvard University, and his Ph.D. in economics from MIT. Dr. Brown has previously served on the faculty at Harvard's Kennedy School of Government, as a Senior Economist with the White House Council of Economic Advisers, and as an economist for the President's Commission to Strengthen Social Security. In 2006, he was nominated by the President and confirmed by the U.S. Senate as a Member of the Social Security Advisory Board, a position in which he served through September 2008. He also serves as a Trustee for TIAA, and also serves on the Board of the American Risk and Insurance Association. In 2008, Dr. Brown received the Early Career Scholarly Achievement Award from the American Risk and Insurance Association, and the TIAA-CREF Paul A. Samuelson Award for Outstanding Scholarly Writing on Lifelong Financial Security. His also a founding co-editor of the Journal of Pension Economics and Finance


Do Consumers Know How to Value Annuities? Complexity as a Barrier to Annuitization

-- Jeffrey R. Brown, Arie Kapteyn, Erzo F.P. Luttmer, and Olivia S. Mitchell

This paper provides evidence that complexity of the annuitization decision process - rather than a preference for lump-sums - may help explain observed low levels of annuity purchases. We test this using Social Security benefits as our choice setting in an experimental module of the RAND American Life Panel. Although average annuity valuations under some elicitation methods are quite close to actuarial values, these averages mask notable heterogeneity in responses, including substantial numbers of respondents who provide responses that are hard to reconcile with reasonable parameter assumptions.

Strikingly, we also find that responses to willingness-to-pay versus willingness-to-accept are negatively correlated. Financially literate consumers are better able to offer responses that are consistent across alternative ways of eliciting preferences for annuitization, though even for them it is difficult to explain much of the observed cross-sectional variation in annuity demand. Our results raise doubts about whether consumers can make utility-maximizing choices when confronted with the decision about whether to buy annuities in the real-world context. Accordingly, observers should be cautious using observed demand for annuities to draw conclusions about the welfare consequences of annuitization.