Explaining Why Retirees Do Not Choose Annuities in Korea: A Probability of Consumption Shortfall Approach

Dong-Hwa Lee¹, Jun-Hee An¹ and Joo-Ho Sung^1,

¹Department of Business, School of Management, Kyung Hee University

Cite this paper:
Dong-Hwa Lee, Jun-Hee An and Joo-Ho Sung. Explaining Why Retirees Do Not Choose Annuities in Korea: A Probability of Consumption Shortfall Approach. Journal of Finance and Economics. 2018; 6(4):125-133. doi: 10.12691/jfe-6-4-2

Abstract

Many assume that for retirees, purchasing an annuity is a better option than self-annuitization in the decumulation period. In Korea, retirees have shown a strong preference for properties (real estate), and a decision to annuitize has been extremely rare. Using a genetic algorithm, we show that self-annuitization can be recommended as an optimal choice for retirees in Korea if they consider properties as one of the investment options. We set three scenarios that a worker can choose at retirement: self-annuitization, purchasing a whole life annuity, and mixed strategy. We then calculate an optimal asset allocation for each scenario capable of minimizing probability of consumption shortfall (PCS). An important observation is achieved: the optimal asset allocation for minimizing PCS vary by the income quintiles, and PCS rises significantly as the preference for purchasing a whole-life annuity increases. In case of a large reduction in consumption after retirement, however, annuitization may be a better option for retirees in the lowest income quintile.

Keywords:
annuity puzzle self-annuitization annuitization probability of consumption shortfall optimal asset allocation

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