Annuity Markets Book

List of Figures xiv

List of Tables xviii

1 Introduction and the context of annuity markets 1

1.1 Context of annuities within pensions policy 2

1.2 Structure of the book 16

2 Description of annuity markets 19

2.1 Types of annuities 19

2.2 Data on annuity rates 27

2.2.1 Purchased life annuities (voluntary) 28

2.2.2 Compulsory purchase annuities market 35

3 A short history of annuities 43

3.1 Annuities from Classical Times up to the Middle Ages 43

3.2 Annuities in the period of developing financial markets 46

3.3 Annuities and UK pension provision since 1945 53

3.4 Recent developments in UK financial markets 64

4 Modelling life expectancy 70

4.1 Definitions, concepts, and actuarial notation 70

4.2 Mortality data in the UK 76

4.3 Patterns of mortality 82

4.4 Projecting mortality in the future 86

5 Annuity markets around the world 95

5.1 Australia 98

5.2 Chile 100

5.3 Germany 106

5.4 Italy 107

5.5 Singapore 109

5.6 Sweden 111

5.7 Switzerland 112

5.8 United States of America 115

6 Money's worth calculations 117

6.1 Evidence on money's worth of UK annuities 118

6.2 Evidence on money's worth in the UK's compulsory annuities market 122

6.3 Evidence on international money's worth 131

7 Annuity demand theory 140

7.1 A simple model of annuity demand 141

7.2 Annuitization and purchasing annuities 148

7.3 Expected-utility maximization 150

7.4 Risk aversion and the form of risk 157

7.5 Exotic utility functions 161

7.6 Solving expected utility models 165

7.7 Numerical simulations 170

8 Reasons for the annuity puzzle 180

8.1 Social welfare payments and pre-annuitized wealth 181

8.2 Investing in alternative assets ordeferring annuitization 184

8.3 The pattern of expenditure in retirement 189

8.4 Theory of adverse selection in annuity markets 192

8.4.1 The Eckstein-Eichenbaum-Peled approach 193

8.4.2 The adverse selection models of Abel and Walliser 196

8.5 Behavioural factors 200

8.5.1 Cumulative prospect theory and loss aversion 201

8.5.2 Framing effects 204

8.5.3 Poor financial education 206

9 Evidence on the workings of annuity markets 210

9.1 Evidence on selection effects 210

9.2 Evidence on the demand for annuities 219

10 Supply of annuities 226

10.1 Market shares of annuity business in the UK 228

10.2 Regulation of annuity providers 234

10.2.1 EU regulations and Solvency 2 234

10.2.2 UK annuity regulation 235

10.3 Managing interest rate risk and bond markets 241

10.4 Managing longevity risk 246

10.4.1 Longevity bonds 248

10.4.2 Reinsurance and securitization 249

10.4.3 Example of mortality securitization 252

10.4.4 Mortality swaps 256

11 Conclusions 259

Glossary 266

Bibliography 268

Index 282