DP18811 Hedging mortality risk over the life-cycle - the role of information and borrowing constraints
Knowledge on mortality risk unfolds over the life-course and questions whether longevity risk should be hedged by acquiring annuities sequentially alongside an evolving information set. It is shown to be optimal for risk averse households to annuitize all old-age consumption already as young based on population weighted survival probabilities (pooling), even if fair risk class specific annuities are available later in life. This savings strategy implies complete insurance. This result may even hold when risk class is private information, but it relies critically on the young being able to front-load annuitization which may entail borrowing. With a binding borrowing constraint, some annuitization is postponed to later in life at the cost of less risk diversification. A mandated pooled annuity targeting the middle-aged lessens the borrowing constraint for the young, may overcome market failures improving welfare for all risk classes, and even in some cases implement the first-best allocation.
