Selection Effects in the United Kingdom Individual Annuities Market

Abstract

This paper explores adverse selection in the voluntary and compulsory individual annuity markets in the United Kingdom. Two empirical regularities support standard models of adverse selection. First, annuitants are longer-lived than non-annuitants. These mortality differences are more pronounced in the voluntary than in the compulsory annuity market. We estimate that the amount of adverse selection in the compulsory market is about one half of that in the voluntary market. Second, the pricing of different types of annuity products within each annuity market is consistent with individuals selecting products based, in part, on private information about their mortality prospects.

Too Risk Averse to Purchase Insurance? A Theoretical Glance at the Annuity Puzzle

“…In absence of such a market, the optimal strategy while facing uninsurable risks may then involve investing wealth in buffer assets, such as bonds or stock rather than in annuities. Sinclair Another explanation is related to unfair pricing of annuities, as reported by Mitchell, Poterba, Warshawsky and Brown (1999), Finkelstein andPoterba (2002) and(2004). Lockwood (2010) demonstrates that this aspect, together with bequest motives of a reasonable magnitude, may be sufficient to explain the low level of annuitization.…”

Adverse selection in the annuity market with sequential and simultaneous insurance demand

“…In particular, he distinguishes between two broad classes of individual annuities, that are deferred and immediate annuities, depending on whether there is a waiting period between the premium payment and the beginning of the annuity payouts or not. The role of annuity contracts with escalating payouts in the U.K. annuity market is studied by Finkelstein and Poterba (2002). 3 Yagi and Nishigaki (1993) also employed a model with one working period and two periods of retirement in order to discuss optimal insurance demand of a representative individual.…”

Adverse Selection Spirals

“…In the annuity markets, researchers in several countries including Australia (Doyle et al, 2002), the UK (Finkelstein and Poterba, 2002;Murthi et al, 1999), and the USA (Mitchell and McCarthy, 2001) have found evidence of adverse selection. For example, in Mitchell and McCarthy (2001) international data from the USA, the UK, and several other countries are considered.…”

“…This seems to be consistent with the empirical evidence in the UK market. Finkelstein and Poterba (2002) found that shorter-lives annuitants bought products which had a guarantee period; and longer-lived annuitants appeared to choose products which were back-loaded (i.e. had annual payments which increased over time, in real terms).…”