Optimal Decision-Making for Annuity Insurance Under the Perspective of Disability Risk

Annuity insurance is a crucial financial tool for mitigating risks associated with aging, yet it has not gained significant traction in China’s insurance market, especially amid the challenges posed by an aging population. This study develops a discrete-time multi-period life-cycle model to analyze optimal annuity purchases for China’s middle-aged population under disability risk and explores in depth the impact and underlying mechanisms of disability risk on their annuity insurance purchase decisions. Disability is endogenized via two channels: financial-constraint effects (medical costs and pre-retirement income loss) and stochastic health state transitions with recovery and mortality. Using data from China Health and Retirement Longitudinal Study (2018–2020) to estimate age- and gender-specific transition matrices and data from China Household Finance Survey (2019) to link income with initial assets, we solve the model by the endogenous grid method and simulate actuarially fair annuities. The findings reveal substantial under-demand for annuities among China’s middle-aged population. Under inflation, the modest yield premium of annuities over inflation significantly depresses purchases by middle- and low-wealth households, while high-wealth individuals are jointly constrained by rapidly rising health expenditures and inadequate annuity returns. Notably, behavioral patterns could shift fundamentally under a hypothetical zero-inflation scenario.