Decision Making under Uncertainty and Risk: A Retiree's Perspective on Choosing between Pension Options

Abstract

For most individuals, successful retirement depends on the availability of sufficient funds in appropriate financial instruments to ensure an acceptable level of income for the remainder of that person's life. This application paper considers the situation faced by a specific individual in a South African context on the point of retirement: either accept a life-time guaranteed fixed pension (life annuity) from his employer or withdraw the capital amount and invest it in a so-called living annuity. The decision appears deceptively simple, but is in fact highly dependent on the uncertainty associated with each of the alternatives. A requisite model is developed to capture the key features of the problem and analysed to identify the preferred course of action. Given that this is a personal decision, the individual's subjective assessment of uncertainties and risk appetite are captured and used in the analysis. The purpose of the paper is to illustrate the use of decision making tools to inform a complex decision characterized by uncertainty and risk, as is often encountered in technology management, rather than a multi-attribute value function. Based on the analysis, the preferred choice for the decision maker is identified: accept the guaranteed pension. Conclusions and possible improvements to the model are presented. The approach developed in this paper is general and can be directly applied to, for example, decisions in technology management where uncertainty often plays a role.

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