Estimating international adverse selection in annuities

North American Actuarial Journal,  Oct 2002  by Mitchell, Olivia S,  McCarthy, David

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II. IMPLICATIONS FOR ANNUITY MARKETS

In this section, we draw out the implications of these data for valuations of annuity market products. Previous studies have noted that mortality tables may differ for a wide range of reasons. One possible explanation is that groups of people have distinct mortality probabilities, such as those associated with well-known differentials by sex, age, and income. In developed countries, for instance, women tend to outlive men, particularly at older ages. A different explanation is that life expectancy has increased over time. Hence, if expected future improvements are built into one mortality table used for projections but not another, the two tables cannot be directly compared. Extrapolations of future improvements are particularly important for the development of forward-looking, cohort mortality tables, as distinct from socalled period tables that refer to probabilities at a given point in time (Executive Committee 1999). Finally, there are numerous reasons to expect that mortality patterns will differ across countries, many of them attributable to differential levels of development. For instance, developed nations tend to have higher income levels and better health-care provision than their poorer counterparts, which are socioeconomic factors anticipated to translate into higher life expectancies as compared with their less wealthy neighbors. Of course, within the subset of developed nations, there are also mortality differences across populations, probably due to a wide range of factors including national differences in lifestyle, diet, and climate.

A. Adverse Selection

For the present analysis, the most interesting factor differentiating mortality tables, and the one we focus on in what follows, is the extent of adverse selection. This arises when people who buy life annuities tend to live longer than people who do not buy them (cf. Brown et al. 1999). As a consequence of adverse selection, an actuary pricing annuities and related insurance products would tend to use special survival probability distributions that take account of these distinct survival patterns. Ideally, the expert would obtain actual survival data on annuitants to determine how closely this subpopulation resembled (or differed from) the population as a whole. In addition, it would be anticipated that the impact of selection would depend on the extent to which annuity purchase is a voluntary or a mandatory decision. In the U.K., for example, one component of old-age pension benefits must be annuitized on a compulsory basis while other annuities are voluntary. As a result, experts have devised distinct U.K. mortality tables (by sex) for voluntary and compulsory-purchase annuitants, both of which differ from the general population table (cf. Finkelstein and Poterba 1999). In the U.S., where private annuity purchase is fully voluntary, actuaries have devised both male and female annuitant mortality tables that differ fairly substantially from the associated population tables.