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Decaying Asymmetric Information and Adverse Selection in Annuities

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  • David McCarthy

    (Tanaka Business School, Imperial College)

Abstract

This paper develops an equilibrium model of the annuities market where agents have private information about their mortality, and where the predictive value of this information decays over time. The paper shows that in this case, insurance companies will observe a duration-related trend in the mortality of annuitants under certain conditions. This effect is tested for using a Cox proportional hazards methodology and data from the South African annuities market, which since the early 1990’s has permitted phased withdrawals of retirement savings instead of mandating pure annuitisation. Evidence is equivocal: substantial differences are found between the duration-related mortality trends of different insurance companies, data problems seem to have some effect, and factors outside the model which might change the results cannot be excluded. However, the presence of a strong duration-related trend cannot be decisively rejected. The observed trend indicates that mortality at earlier policy durations is better than at later durations by the equivalent of about 6 years of age, although data factors cannot be precluded as a cause of this trend.

Suggested Citation

  • David McCarthy, 2004. "Decaying Asymmetric Information and Adverse Selection in Annuities," Working Papers wp080, University of Michigan, Michigan Retirement Research Center.
  • Handle: RePEc:mrr:papers:wp080
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    File URL: http://www.mrrc.isr.umich.edu/publications/Papers/pdf/wp080.pdf
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    References listed on IDEAS

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    1. Brown, Jeffrey R., 2001. "Private pensions, mortality risk, and the decision to annuitize," Journal of Public Economics, Elsevier, vol. 82(1), pages 29-62, October.
    2. Bernheim, B Douglas, 1991. "How Strong Are Bequest Motives? Evidence Based on Estimates of the Demand for Life Insurance and Annuities," Journal of Political Economy, University of Chicago Press, vol. 99(5), pages 899-927, October.
    3. Olivia S. Mitchell, 1999. "New Evidence on the Money's Worth of Individual Annuities," American Economic Review, American Economic Association, pages 1299-1318.
    4. Case, Anne & Deaton, Angus, 1998. "Large Cash Transfers to the Elderly in South Africa," Economic Journal, Royal Economic Society, vol. 108(450), pages 1330-1361, September.
    5. Jeffrey R. Brown, 2003. "Redistribution and Insurance: Mandatory Annuitization With Mortality Heterogeneity," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 70(1), pages 17-41.
    6. Tomas Philipson & John Cawley, 1999. "An Empirical Examination of Information Barriers to Trade in Insurance," American Economic Review, American Economic Association, pages 827-846.
    7. Abel, Andrew B, 1986. "Capital Accumulation and Uncertain Lifetimes with Adverse Selection," Econometrica, Econometric Society, vol. 54(5), pages 1079-1097, September.
    8. Paul A. Samuelson, 2011. "Lifetime Portfolio Selection by Dynamic Stochastic Programming," World Scientific Book Chapters,in: THE KELLY CAPITAL GROWTH INVESTMENT CRITERION THEORY and PRACTICE, chapter 31, pages 465-472 World Scientific Publishing Co. Pte. Ltd..
    9. Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-257, August.
    10. Amy Finkelstein & James Poterba, 2002. "Selection Effects in the United Kingdom Individual Annuities Market," Economic Journal, Royal Economic Society, vol. 112(476), pages 28-50, January.
    11. Jeffrey R. Brown & James M. Poterba, 1999. "Joint Life Annuities and Annuity Demand by Married Couples," NBER Working Papers 7199, National Bureau of Economic Research, Inc.
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