provides a regular income stream to its beneficiaries. Therefore, annuitization can be defined as the process of paying a fixed amount of money which is due to an annuity investment to a beneficiary or an annuitant. Annuitization extends your annuity investment into a stream of regular payments to the annuity beneficiary or a surviving spouse in a joint life arrangement. This income is paid to the beneficiaries upon the death of the annuitant. This is a sum of money payable yearly or at other regular intervals as decided by the annuitant.
A Little More on What is Annuitization
As far as annuitization is concerned, individuals offer a tangible capital to a life insurance company in exchange for periodic payments throughout their lifetime or within a time frame. Annuitization has been in practise for years but became a contract offered to the public in the 1800s by life insurance companies. And as become a worthy means of investment.
How Annuitization Works
Annuitization has a fixed calculation rate: the capital offered will determine the amount paid as regular income to the annuitant. The life insurance company pays an amount equivalent of the annuitant’s age and life expectancy rate with the projected interest rate the insurance company will credit to the annuity balance. All of these determine what is paid and the interest accrued by the beneficiary of the annuity at the end of the time frame of the annuity. This calculation works to provide a regular stream of income for the annuity and also benefit the insurance company.
In this type of investment, the life insurance company takes responsibility for the annuitant living long as the payment continues until the death of the annuitant in the case of a lifetime payment period. It is important to note that the payment period is determined by the investor’s lifespan or an investor’s choice of time frame. In both ways, the life insurance company is at risk of long term payments.
If an annuity covers a single life, then the annuity becomes inconsequential upon the death of the annuitant and the annuity balance belongs to the insurer. But where annuity covers for joint lives, then the annuity covers till their death.
Refunding is possible if the annuitant chooses the refund option which allows the beneficiary to receive the proceeds or balance of the annuity. An annuitant may decide to choose a lifetime refund option, but the length of the refund period will affect the regular monthly payment or yearly payment. If the period of the refund is within a wide range of time, then the lower the amount paid regularly. For example, if a refund option is 10years, death must occur within that 10years so that the beneficiary can be refunded and the payout will be reduced.
Reference for “Annuitization”
Academics research on “Annuitization”
The timing of annuitization: Investment dominance and mortality risk, Milevsky, M. A., & Young, V. R. (2007). The timing of annuitization: Investment dominance and mortality risk. Insurance: Mathematics and Economics, 40(1), 135-144. We use preference-free dominance arguments to develop a framework for locating the optimal age (time) at which a retiree should purchase an irreversible life annuity, as a function of current annuity prices and mortality tables. Then, using the institutional characteristics of annuity markets in the US, we show that annuitization prior to age 65–70 is dominated by self-annuitization even in the absence of any bequest motives. And, for retirees who are willing to accept some financial risk in exchange for retaining the benefits of liquidity and bequest, the optimal age can be even later. In addition to the normative implications, these results should help shed light on the so-called annuity puzzle which has been much debated by economists, by focusing attention on the specific ages for which a puzzle can actually be said to exist.
Behavioral obstacles in the annuity market, Hu, W. Y., & Scott, J. S. (2007). Behavioral obstacles in the annuity market. Financial Analysts Journal, 63(6), 71-82. As Baby Boomers enter retirement, they will look to the investment industry for ways to generate income from accumulated savings. Why most retirees do not purchase longevity insurance in the form of lifetime annuities is a long-standing puzzle. Mental accounting and loss aversion can explain the unpopularity of annuities by framing them as risky gambles where potential losses loom larger than potential gains. Moreover, behavioral anomalies can explain the prevalence of “period certain” annuities, which guarantee a minimum number of payouts. Finally, investors may prefer “longevity annuities” purchased today to begin payouts in the future to immediate annuities because investors overweight the small probability of living long enough to receive large future payouts.
Self-annuitization, consumption shortfall in retirement and asset allocation: The annuity benchmark, Albrecht, P., & Maurer, R. (2002). Self-annuitization, consumption shortfall in retirement and asset allocation: The annuity benchmark. Journal of Pension Economics & Finance, 1(3), 269-288. The present paper considers a retiree of a certain age who is endowed with a certain amount of wealth and is facing alternative investment opportunities. One possibility is to buy a single premium immediate (participating) annuity-contract. This insurance product pays a life-long pension payment of a certain amount, depending e.g. on the age of the retiree, the operating cost of the insurance company and the return the company is able to realize from its investments. The alternative possibility is to invest the single premium into a portfolio of mutual funds and to periodically withdraw a fixed amount that is assumed to be equivalent to the consumption stream generated by the annuity. The particular advantage of this self-annuitization strategy compared to the life annuity is its greater liquidity and the possibility of leaving money for heirs. However, the risk of self-annuitization is to outlive the assets before the uncertain date of death. The risk can thus be specified by considering the probability of running out of money before the uncertain date of death. The determination of this personal probability of consumption shortfall with respect to German insurance and capital market conditions is the objective of this paper.
Integrating optimal annuity planning with consumption–investment selections in retirement planning, Gupta, A., & Li, Z. (2007). Integrating optimal annuity planning with consumption–investment selections in retirement planning. Insurance: Mathematics and Economics, 41(1), 96-110. nnuities can be effective tools in managing longevity risk in retirement planning. This paper develops a framework that merges annuity purchase decisions with consumption–investment selections in retirement planning. After introducing a pricing and a benefit payment model for an annuity, we construct a multi-period wealth evolution model. An optimization problem is formulated with an objective of maximizing lifetime utility of consumption and wealth. Optimal decisions are determined as a trade off between consumption and investment among an annuity, a risky and a risk-free asset. Computational results are provided to illustrate the practical implications of the framework.
Lifecycle portfolio choice with systematic longevity risk and variable investment—Linked deferred annuities, Maurer, R., Mitchell, O. S., Rogalla, R., & Kartashov, V. (2013). Lifecycle portfolio choice with systematic longevity risk and variable investment—Linked deferred annuities. Journal of Risk and Insurance, 80(3), 649-676. This article assesses the impact of variable investment‐linked deferred annuities (VILDAs) on lifecycle consumption and portfolio allocation, allowing for systematic longevity risk. Under a self‐insurance strategy, insurers set premiums to reduce the chance that benefits paid exceed provider reserves. Under a participating approach, the provider avoids taking systematic longevity risk by adjusting benefits in response to unanticipated mortality shocks. Young households with participating annuities average one‐third higher excess consumption, while 80‐year‐olds increase consumption about 75 percent. Many households would prefer to participate in systematic longevity risk unless insurers can hedge it at a very low price.