Annuity Markets in Comparative Perspective: Do Consumers Get Their Money’s Worth?

Abstract

Pension reforms normally focus on the
\n accumulation phase, plus term insurance that provides
\n bnefits for the disabled and for dependent survivors, all of
\n which are immediate concerns. Decumulation of the capital in
\n workers' retirement savings accounts appears to be far
\n in the future. But in the second generation of reforms,
\n countries have begun paying attention to eventual
\n decumulation--either through gradual withdrawals or through
\n annuitization, which provides longevity insurance. At this
\n point, it becomes important to learn whether annuity markets
\n exist and how they operate. The authors summarize
\n preliminary results of a continuing research project that
\n analyzes annuity markets in Australia, Canada, Chile,
\n Israel, Singapore, Switzerland, and the United Kingdom. They
\n focus on understanding whether annuity markets can be relied
\n upon to provide reliable retirement income at reasonable
\n prices. One way to approach this question is to explore
\n whether the expected payouts and the
\n "money's-worth ratio" differ across
\n countries, and if so, why, and what light can be thrown on
\n the existence and amount of adverse selection. Annuity
\n markets are poorly designed for various reasons: worker
\n myopia, precautionary and bequest saving (not erved by most
\n annuity products), distrust of insurance companies (and
\n unwillingness to turn sizeable savings over to them),
\n adverse selection, and the crowding-out effect of social
\n security (Which automatically annuitizes the largest share
\n of people's retirement wealth). Preliminary findings
\n suggest that the cost of annuities is lower than might be
\n expected. When the risk-free discount rate is used, the
\n money's-worth ratios of nominal annuities based on
\n annuitant mortality tables exceed 90 percent--neither the
\n industry "take" nor the effects of adverse
\n selection appear to be as large as anticipated. But real
\n annuities (in Chile, Israel, and the United Kingdom) have
\n money's-worth ratios 7 to 9 percent lower than those of
\n nominal annuities. And when the "riskier"
\n corporate bond rate is used for discounting purposes, there
\n is a further 7 percent reduction. The main policy issues
\n include public versus private provision, the role of
\n insurance companies in term and risk intermediation, the
\n level of compulsory annuitization, and the need for robust
\n regulation of annuity providers.