Optimal life cycle portfolio choice with variable annuities offering liquidity and investment downside protection |
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| Affiliation: | 1. Finance Department, Goethe University, Grueneburgplatz 1 (Uni-PF. H 23), Frankfurt am Main, Germany;2. Wharton School, University of Pennsylvania, 3620 Locust Walk, 3000 SH-DH, Philadelphia, PA 19104, United States;1. Research School of Finance, Actuarial Studies and Statistics, Australian National University, Australia;2. Cass Business School, City, University of London, United Kingdom;1. Université libre de Bruxelles, Department of Mathematics, Boulevard du Triomphe, CP 210, Brussels 1050, Belgium;2. Dipartimento di Matematica, Università degli Studi di Padova, Italy;3. De Vinci Research Center, Finance Group, Leonard de Vinci Pôle Universitaire, Paris La Défense, France;1. Bocconi University, Milan 20135, Italy;2. Finance and Econometrics Groups, Netspar, Tilburg University, Tilburg 5000 LE, The Netherlands |
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| Abstract: | This paper assesses optimal life cycle consumption and portfolio allocations when households have access to Guaranteed Minimum Withdrawal Benefit (GMWB) variable annuities over their adult lifetimes. Our contribution is to evaluate demand for these products which provide access to equity investments with money-back guarantees, longevity risk hedging, and partially-refundable premiums, in a realistic world with uncertain labor and capital market income as well as mortality risk. Others have predicted that consumers will only purchase such annuities late in life, but we show that they will optimally purchase GMWBs prior to retirement, consistent with their recent rapid uptick in sales. Additionally, many individuals optimally adjust their portfolios and consumption streams along the way by taking cash withdrawals from the products. These products can substantially enhance consumption, by up to 10% for those who experience highly unfavorable experiences in the stock market. |
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| Keywords: | Dynamic portfolio choice Longevity risk Variable annuity Money-back guarantee Liquidity Retirement income |
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