Annuity Markets

by Edmund Cannon, Ian Tonks

Overview

The Pension Crisis concerns the changing demographic profile of the economy: an increasing number of elderly persons supported by fewer young people. Governments around the world are responding to this impending crisis by shifting their pension policies away from pay-as-you-go systems towards individual savings schemes. These savings need to be converted into a pension at retirement, and annuities provide this function. This book is a comprehensive study of annuity markets. The book starts by outlining the context of public policy towards pensions, and explains the different types of annuities available, focusing on the UK which has the largest annuity market in the world. It examines how annuities are priced, and describes the techniques of mortality measurement. As a background, it provides a history of annuities, and the experience of annuity markets in a number of other countries. The book outlines the economic theory behind annuities, and explains how annuities insure consumers against longevity risks. It goes on to describes how annuities markets function: how they work, and whether they are efficient, leading onto a discussion of the annuity puzzle. The book concludes by discussing the regulatory framework, assets available to back annuity liabilities, and recent developments in annuity markets.

Product Details

ISBN-13:	9780191607592
Publisher:	OUP Oxford
Publication date:	10/02/2008
Sold by:	Barnes & Noble
Format:	eBook
File size:	25 MB
Note:	This product may take a few minutes to download.

About the Author

Dr Edmund Cannon is a Senior Lecturer in Economics at the University of Bristol. His research includes work on pension economics; the effect of demographic change on the macroeconomy; endogenous growth theory; and the rôle of financial markets and transport in economic development. He has published in leading economics and economic history journals. He teaches macroeconomics and econometrics, is Deputy Director of the Economics Network of the Higher Education Academy and has taught at the University of Oxford and the University of Verona. He has acted as a consultant to the UK water industry and advised the Department of Work and Pensions. Professor Ian Tonks is Director of Xfi Centre for Finance and Investment at the University of Exeter. During the academic year 2006/07 he is Senior Houblon-Norman Fellow at the Bank of England. His research focuses on pension economics; fund manager performance; market microstructure and the organisation of stock exchanges; directors' trading; and the new issue market. He has published in leading finance and economics journals, and teaches across all areas of financial economics including asset pricing, corporate finance, market efficiency and performance measurement. He is a consultant to the Financial Markets Group, and the Centre for Market and Public Organisation. He has acted as a consultant to a number of commercial and regulatory organisations including the London Stock Exchange, the Competition Commission, and the Financial Services Authority, and has advised the Department of Work and Pensions, and the House of Commons Select Committee on issues in pensions.

Table of Contents

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