The Pension Research Council
Working Paper

Optimal Life Cycle Portfolio Choice with Variable Annuities Offering Liquidity and Investment Downside Protection

Vanya Horneff, Olivia S. Mitchell, Raimond Maurer, and Ralph Rogalla
WP2013-04

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Abstract — We evaluate lifecycle consumption and portfolio allocation patterns resulting from access to Guaranteed Minimum Withdrawal Benefit (GMWB) variable annuities, one of the most rapidly-growing financial innovations over the last two decades. A key feature of these products is that they offer access to equity investments with downside protection, hedging of longevity risk, and partially-refundable premiums. Welfare rises since policyholders exercise the product's flexibility by taking withdrawals and dynamically adjusting their portfolios and consumption streams. Consistent with observed behavior, differences across individuals' cash out and annuitization patterns result from variations in realized equity market returns and
labor income trajectories.