research

Insuring Longevity Risk While Having Multiple Saving Accounts

A TFI research project by Abigail Hurwitz & Orly Sade
Posted on October 22, 2020

"Insuring longevity risk while having multiple saving accounts" is one of the research projects supported by the Think Forward Initiative.

In this study, Abigail Hurwitz and Orly Sade investigate the possible consequences of having multiple savings accounts for payout decisions at retirement. They find that the smaller (larger) the accumulated sum of money in the pension account, the lower (higher) the propensity to annuitize upon retirement. What does this imply for the savers, the financial institutions and the innovators developing financial apps that support retirement decisions?

Download the report or read the summary below to find out.

SUMMARY

Imagine the following scenario: you just retired, and you need to decide how to withdraw your savings. How much of it will you invest in an annuity (i.e. a sum of money, typically paid every month of the year for the rest of a retiree’s life) and how much will you cash out as a lump sum (a single payment made upon retirement)? Your goals are to avoid exhausting your assets too soon and also have enough money to face potential liquidity shocks in the future. This intricate decision is most often made by older individuals, and can have significant consequences on their well-being. Given both its complexity and importance, there is growing academic and practical interest aimed at enhancing both long-term savings and demand for longevity insurance products.

Imagine now that you saved for retirement via different products or pension funds. Will the distribution of your funds according to the size of the accounts affect your withdrawal decisions? If you are rational, and there are no frictions, it is expected that you will allocate your accumulated savings between an annuity and a lump sum according to your financial need, regardless of the size or distribution of the different accounts. Given the fact that most individuals will save for retirement via different products and accounts (as a result of job changes throughout one’s career), there is a clear need to better understand the effect of having multiple accounts on the decision to withdraw funds upon retirement. Yet, there is relatively little empirical evidence on this issue.

In our research project, we investigated empirically and experimentally if the distribution of pension savings across various providers and the relative size of each specific savings account affects individuals’ decision to either annuitize or cash out their saving accounts at retirement. We rely on a unique and very detailed proprietary dataset from a leading insurance company in Israel, which includes information regarding the annuitization decisions of retirees and a rich set of parameters that describes these individuals (during the years 2009–2013).


Our results

Specifically, we document a significant and positive effect of the size of the accumulated funds on the decision to annuitize: the smaller (larger) the accumulated sum of money in the pension account, the lower (higher) the propensity to annuitize upon retirement. In a further set of online and lab experiments, we again show that the very existence of a small account within a portfolio may in fact alter annuitization rates related to that total amount. In other words, diversification across accounts may lead to different decisions and in turn, different financial outcomes for both individuals and financial institutions.

The fact that annuitization rates differ with account size is indeed puzzling and can be related to the possibility of having multiple savings accounts. We further studied this phenomenon by conducting three more experiments: an online survey, an incentivized experiment in the laboratory, and an experimental survey of financial experts.

Our Online survey (conducted in 2018 and 2019) yielded particularly interesting results. In this experiment, participants were asked to divide a total sum of money that was saved for retirement between an annuity and a lump sum. A total of 1,971 participants (from a representative sample of the Israeli population) were randomly assigned to one of five conditions (with different distributions of the virtual savings amount). Our results suggest that regardless of the division of funds throughout the accounts, the mean proportion of funds participants chose to withdraw as a lump sum from their larger account is about one third, implying a preference for the annuity option (a result that is consistent with actual annuity take-up rates in Israel found in a recent paper by Hurwitz and Sade, 2019). However, the small accounts were significantly more likely to be withdrawn as a lump sum, and the smaller the amount, the more likely it was to be cashed out.

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Fig 1. Proportion of total accumulation withdrawn as a lump sum, separately for small and large accounts, Online survey

Our research provides evidence regarding the effect of holding multiple savings accounts on the withdrawal decision upon retirement. Given the global dynamic job market and high unemployment rates due to the current COVID-19 outbreak, individuals are expected to change jobs, and in turn, hold several savings accounts. This will have important implications in the future about the decisions that individuals will make about how to make use of their pension savings for retirement.


Implications

Our results have important policy implications both for savers and financial institutions. While this is not the sole explanation of annuitization choice, our findings suggest that mental accounting plays a role by causing retirees to perceive smaller and larger pension accounts differently, and hence leading them to make different decisions about disbursements. We recognize that mental accounting is very relevant to the valuation of the costs and benefits associated with multiple retirement savings accounts across several providers and may be considered when discussing the presentation of information to retirees as well as when developing financial technology applications that can overcome the documented tendencies (e.g., an app that aggregates the account information and presents the overall accumulations before the annuitization decision, and vice versa, depending on needs and desires).

One may argue that some individuals are fully aware of lacking self-control (O’Donoghue and Rabin, 1999), hence the fact that they hold multiple savings accounts is an intended mechanism, aimed at encouraging financial discipline (Zhang and Sussman, 2018). Specifically, saving via multiple accounts may allow in the future to withdraw the small as lump sum while the other, larger account, is designated to annuitization. This insight may be used by suggesting individuals to open more than one savings account, each designated to a different goal. Further research is required, however, to fully understand the consequences of such a suggestion.

Our results can also help in the design of regulatory interventions. In future research, we hope to study the consequences and implications of first presenting retirees with their total accumulation and discussing their various retirement needs, before they make the annuitization decisions. 

References

  • Hurwitz, A., & Sade, O. (2019). An investigation of time preferences, life expectancy, and annuity versus lump sum choices: Can smoking harm long-term saving decisions?. Journal of Economic Behavior & Organization. In press
  • O’Donoghue, T., Rabin, M., (1999). Addiction and self-control. In: Elsner, J. (Ed.). Addiction: Entries and Exits. New York: Russell Sage Foundation, 169-206
  • Zhang, C. Y., & Sussman, A. B. (2018). Perspectives on mental accounting: An exploration of budgeting and investing. Financial Planning Review, 1(1-2), e1011.