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Award-winning paper highlights demand for life annuities

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A research paper that analyzed life annuity versus lump sum selections among retired public employees won the 18th annual TIAA-CREF Paul A. Samuelson Award for Outstanding Scholarly Writing on Lifelong Financial Security.

The paper, “How Do Retirees Value Life Annuities? Evidence from Public Employees,” was written by John Chalmers of the University of Oregon and Jonathan Reuter of Boston College. By investigating whether retirees from the Oregon Public Employees Retirement System (PERS) choose a lump sum or a life annuity, the authors debunked conventional wisdom that there is low demand for life annuities. In fact, based on a sizable sample of 32,000 retirees between 1990 and 2002, 85 percent of PERS retirees opted to receive all of their pension benefits in the form of lifetime annuity payments. The research paper was published in The Review of Financial Studies in 2012.

“Our paper helps economists better understand the disconnect between economic models which predict that retirees will use their 401(k)s to buy life annuities and the real world where demand for life annuities is quite low,” Reuter said in a statement.

Among the other findings of the Chalmers/Reuters research:

  • Retirees in poor health were less likely than healthier counterparts to select a life annuity, indicating that a person’s perceived longevity impacts investment choices.
  • Demand for life annuities does not correspond to the actuarial value of the lifetime annuity payments, which implies that retirees lack the financial knowledge to compare life annuities to lump sums.
  • Higher stock market returns tend to dampen demand for life annuities, suggesting that some PERS retirees may overvalue the projected investment returns a lump sum will generate.

To boost annuitization rates among retirees, the authors recommend that plan sponsors reduce search costs by incorporating life annuities into defined contribution retirement accounts as well as presenting participants a number of lifetime annuity payment options. In addition, plan sponsors were advised to provide access to basic financial education and unbiased financial advice to retirees before they make their selection.

“There’s widespread concern that many of today’s retirees will outlive their savings. Life annuities are a solution to longevity risk, but they are surprisingly unpopular,” said Samuelson Award judge James Choi, associate professor of finance at Yale University, in a statement. “This paper examines a setting where most retirees do take up life annuities, which suggests that life annuities will be chosen with significant frequency under the right circumstances.”

The award is named after Nobel Prize winner and former CREF trustee Paul A. Samuelson. It is awarded annually in recognition of a notable research paper containing ideas that the public and private sectors can use to promote Americans’ lifelong financial wellbeing. A $10,000 prize is awarded to the winner.

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