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Value Analysis of Life Annuity Using Expected Utility Function - with Focus on AEW(Annuity Equivalent Wealth) at Retirement -

  • Journal of Insurance and Finance
  • 2009, 20(2), pp.3-32
  • Publisher : Korea Insurance Research Institute
  • Research Area : Social Science > Business Management

Yoonkyung Yuh 1 Yang Jaehwan 2

1이화여자대학교
2서울시립대학교

Accredited

ABSTRACT

The purpose of this paper is to calculate and analyze value of life annuity which is commonly purchased by pre-retirees in Korea. Instead of using financial value of life annuity such as MW(Money’s Worth) rate, IRR(Internal Rate of Return), and other similar measures, we focus on calculating the value of life annuity which is based on individual’s utility function. To calculate AEW(Annuity Equivalent Wealth) which measures the value of annuity based on the utility function, we use a life-cycle based optimization model, and as a solution procedure, we utilize the DP(Dynamic Programming) techniques. The results indicate that value of life annuity is high regardless of the gender and the degree of risk aversion. Especially, the utility of life annuity increases for a typical male who has higher mortality rate than a typical female when annuity payment is determined under the fair pricing system compared to the case where annuity payment is determined under the uniform pricing system. Further, the value of life annuity decreases as pre-existing annuity level increases and it increases as the annuitization age of an individual increases. Finally, the result shows that if we use a realistic constraint of annual minimum consumption level in the model, then the value of life annuity increases.

Citation status

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