Two-phase annular flow in vertical pipes is one of the most common and important flow regimes in fluid mechanics, particularly in the field of building drainage systems where discharges to the vertical pipe are random and the flow is unsteady. With the development of experimental techniques and analytical methods, the understanding of the fundamental mechanism of the annular two-phase flow has been significantly advanced, such as liquid film development, evolution of the disturbance wave, and droplet entrainment mechanism. Despite the hundreds of papers published so far, the mechanism of annular flow remains incompletely understood. Therefore, this paper summarizes the research on two-phase annular flow in vertical pipes mainly in the last two decades. The review is mainly divided into two parts, i.e., the investigation methodologies and the advancement of knowledge. Different experimental techniques and numerical simulations are compared to highlight their advantages and challenges. Advanced underpinning physics of the mechanism is summarized in several groups including the wavy liquid film, droplet behaviour, entrainment and void fraction. Challenges and recommendations are summarized based on the literature cited in this review.