The Economics of Death
Annuities and Longevity Risk
How annuities turn savings into guaranteed lifetime income, why they protect against the risk of outliving money, and why few people buy them.
No one knows how long they’ll live. This creates longevity risk: outliving your savings.
Annuities
- An annuity turns a lump sum into regular income for life.
- Insurers pool many people: those who die early subsidise those who live long.
India
- NPS subscribers must use at least 40 percent of their corpus to buy an annuity at retirement (with some exceptions).
- LIC and other insurers sell annuities.
The annuity puzzle
- Economists expect people to buy more annuities, given longevity risk.
- Few do, a puzzle economists call the “annuity puzzle”.
Reasons
- Desire to leave bequests.
- Fear of dying early and “losing” money.
- Low annuity rates.
- Lack of trust or understanding.
Economic insight
Annuities are insurance against living long, not an investment.
The pooled income
A retiree buys an annuity with part of her savings. She receives monthly income for life, no matter how long she lives.
Thinking annuities are poor investments because some people die early
They insure against living longer than savings last.
Key takeaways
- Longevity risk means outliving savings.
- Annuities provide lifetime income.
- NPS requires 40 percent to be used for annuities.
- Few people buy annuities, the annuity puzzle.
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