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Annuities Markets Around the World: Money’s Worth and Risk Intermediation

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  • Estelle James

    ()
    (World Bank (consultant))

  • Xue Song

    (Institute for Women’s Policy Research)

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    Abstract

    Annuities markets around the world are small. However, they have been growing in recent years and are likely to grow further as a result of reforms in public social security systems and private pension plans, that partially replace defined benefit plans with funded defined contribution plans. When people retire they may choose, and are sometimes required,to annuitize these defined contribution savings. Therefore, it is important to learn whether or not annuities markets exist,how they operate and what kinds of market failure can be anticipated. Several papers have already analyzed US annuitie smarkets. This paper extends that analysis by examining annuities markets in other countries. We present evidence from Canada,the UK, Switzerland, Australia, Israel, Chile and Singapore—a variety of high and middle-income countries—and replicate the results from the US. This paper focuses on analyses of the expected present discounted value (EPDV) of cash flows from the annuity, and the money’s worth ratio (MWR), which is the EPDV divided by the initial premium cost. We find that, when discounting at the risk-free rate, MWR’s for annuitants are surprisingly high--greater than 95% in most countries and sometimes greater than 100%. MWR’s for the average population member are lower but still exceed 90% in most cases. We show that differential interest rate structures largely explain differential monthly payouts across countries,while differential mortality rates, especially projected improvement factors, help explain differences in measured MWR’s, given these monthly payouts and interest rates. The high MWR’s raise the question: How do insurance companies cover their costs despite these high MWR’s? We hypothesize that for each annuity sale, insurance companies get a large sum of money up-front that they invest in a portfolio of corporate bonds, mortgages, and some equities, earning a rate of return that exceeds the risk-free rate by 1.3% or more per year. They turn this “risky” portfolio into a safer annuity by a variety of risk-intermediation, term-intermediation techniques. This allows them to sell a product that is nearly risk-free, while earning a “spread” that covers their costs. We present data on cost and investment returns that are consistent with this hypothesis. The limited opportunity to earn this spread may help explain why price indexed annuities in the UK charge higher loads to cover their costs and risks. For consumers who would prefer to accept this investment risk and capture this spread themselves, the appropriate discount rate is higher and the MWR is lower, helping to explain the low demand for annuities in voluntary markets.

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    Bibliographic Info

    Paper provided by Center for Research on Pensions and Welfare Policies, Turin (Italy) in its series CeRP Working Papers with number 16.

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    Length: 96 pages
    Date of creation: Dec 2001
    Date of revision:
    Handle: RePEc:crp:wpaper:16

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    Related research

    Keywords: Annuities markets;

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    Citations

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    Cited by:
    1. Philippe FEVRIER & Laurent LINNEMER & Michael VISSER, 2010. "Testing for Asymmetric Information in the Viager Market," Working Papers 2010-01, Centre de Recherche en Economie et Statistique.
    2. Monika Buetler & Federica Teppa, 2005. "Should you Take a Lump-Sum or Annuitize? Results from Swiss Pension Funds," CESifo Working Paper Series 1610, CESifo Group Munich.
    3. Ferro, Gustavo, 2008. "On annuities: an overview of the issues," MPRA Paper 20209, University Library of Munich, Germany, revised Oct 2009.
    4. Robert Holzmann & Richard Hinz, 2005. "Old Age Income Support in the 21st century: An International Perspective on Pension Systems and Reform," World Bank Publications, The World Bank, number 7336, October.
    5. Estelle James & Guillermo Martinez & Augusto Iglesias, 2004. "Payout Choices by Retirees in Chile: What Are They and Why?," Working Papers wp068, University of Michigan, Michigan Retirement Research Center.
    6. Alejandra Cox-Edwards & Estelle James, 2006. "Crowd-out, Adverse Selection and Information in Annuity Markets: Evidence from a New Retrospective Data Set in Chile," Working Papers wp147, University of Michigan, Michigan Retirement Research Center.
    7. Konstantin Petrichev & Susan Thorp, 2007. "The Private Value of Public Pensions," Research Paper Series 211, Quantitative Finance Research Centre, University of Technology, Sydney.
    8. Walker, Eduardo, 2006. "Annuity markets in Chile : competition, regulation - and myopia ?," Policy Research Working Paper Series 3972, The World Bank.
    9. Estelle James & Alejandra Cox Edwards & Rebeca Wong, 2012. "The Gender Impact of Pension Reform," World Bank Other Operational Studies 13046, The World Bank.
    10. Ferro, Gustavo, 2008. "Un impulso al mercado de rentas vitalicias en España
      [Promoting the annuities market in Spain]
      ," MPRA Paper 20211, University Library of Munich, Germany, revised Jul 2008.

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