Why Don't the People Insure Late Life Consumption? A Framing Explanation of the Under-Annuitization Puzzle

April 2008
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Summary

According to standard economic models, a risk-averse consumer who faces uncertainty about length-of-life should place a high value on life annuities that provide guaranteed income for life. Yet numerous studies show that few consumers voluntarily annuitize their retirement savings. As a whole, however, the literature has failed to find a sufficiently general explanation of consumer aversion to annuities. This paper suggests that a psychologically richer model of consumer behavior can explain under-annuitization. Since the development of prospect theory, economists have increasingly understood the importance of framing in economic decisions. While loss/gain asymmetry—the differential responses when a choice is framed as a loss than when it is framed as a gain—is the most commonly discussed example, framing is a more general phenomena. Put simply, experimental findings suggest that choices are not based solely on material consequences, but instead are filtered through the particular frame that individuals use to interpret the choices. We propose that instead of viewing the problem through the consumption frame (focusing on the end result of what can be spent over time), many consumers adopt an investment frame (focusing on the intermediate results of return and risk features when choosing assets and not considering the consequences for consumption).