Faculty of Economics and Business Administration Publications Database

Optimal life cycle portfolio choice with variable annuities offering liquidity and investment downside protection

Horneff, Vanya
Mitchell, Olivia S.
Rogalla, Ralph
Volume: 63
Pages: 91 - 107
Month: July
ISSN-Print: 0167-6687
Link External Source: Online Version
Year: 2015
Keywords: Dynamic portfolio choice; Longevity risk; Variable annuity; Money-back guarantee; Liquidity; Retirement income

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.