Variable Annuities and the Option to Seek Risk - Why Should You Diversify?

We analyze the impacts of an additional rider which is incorporated in recent retirement planning products. The payoff of these products is linked to the performance of a multi asset investment strategy and includes a minimum interest rate guarantee on the contributions.In addition, the buyer receives the option to decide on the investments dynamically. Prominent examples are so called variable annuities, in particular guaranteed minimum accumulation benefits (GMABs). Due to the embedded guarantee, these products are interesting for risk averse investors who, in general, benefit from diversification. However, to stay on the safe side the price setting of the provider must take into account the most risky strategy.This implies that the investor mitigates optimally between the diversification and the worst case strategy. We analyze the distortion and utility effects caused by the additional rider in the presence of background risk and borrowing constraints. A simulation analysis sheds light on the question if the additional rider is worth its costs. We take account of the utility gained by the possibility to adapt to individual preferences and changing personal pension situations. In particular, we illustrate to what extent these gains can compensate the utility loss caused by the upper price setting due to the worst case strategy