Merging Asset Allocation and Longevity Insurance: An Optimal Perspective on Payout Annuities

Peng Cheng; Milevsky, Moshe A.
June 2003
Journal of Financial Planning;Jun2003, Vol. 16 Issue 6, p52
Academic Journal
This article explores the need for longevity insurance during retirement and establishes a framework to study the total asset and product allocation decision. Investors must consider two risk factors when making decisions on what products should be used to generate income in retirement. These are financial market risk and longevity risk. The effectiveness of the modern portfolio theory is questionable when dealing with asset allocations for individual investors in retirement, because it does not consider longevity risk and the portfolio's random time horizon. Longevity risk, the risk of outliving one's resources, is substantial and is the reason that lifetime annuities will grow in popularity. Despite the benefits of longevity insurance and fixed payout amounts, there are disadvantages with a portfolio that consists solely of fixed annuities. Because the payments are the same year after year, purchasing power is eroded as the annuitant gets older. Besides the impact of inflation on fixed payout annuities, a second concern is that investors cannot trade out of the fixed payout annuity once it is purchased. The lack of liquidity within a fixed product impedes the optimal asset allocation process and makes the fixed payout annuity less desirable.


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