Adjusted Money's Worth Ratios in Life Annuities
AbstractThe Money's Worth Ratio (MWR) measures an annuity's actuarial fairness. It is calculated as the discounted present value of expected future payments divided by its cost. We argue that from the perspective of annuitants, this measure may overestimate the value-for-money obtained, since it does not adjust for liquidity or risk factors. Measuring these factors is challenging, requiring detailed knowledge of assets, liabilities, and of the stochastic processes followed by them. Using a multi-factor continuous-time model, we propose a simple solution for an adjusted MWR (AMWR), which does consider illiquidity and default risk. We implement this solution for the competitive Chilean annuity market, which offers MWRs above 1, finding that indeed these ratios are biased upward 7 percent on average. We also present estimates of default option values, asset insufficiency probabilities and implied credit spreads for each annuity provider.
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Bibliographic InfoPaper provided by Instituto de Economia. Pontificia Universidad Católica de Chile. in its series Documentos de Trabajo with number 434.
Date of creation: 2013
Date of revision:
money's worth ratios; annuities; insurance companies; credit risk; liquidity premium; default probability; multi-factor continuous time models; emerging markets; Chile;
Find related papers by JEL classification:
- G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
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