Faculty of Actuarial Science and Insurance Seminar with Colin Ramsay, University of Nebraska-Lincoln.

Doubly Enhanced Annuities

Abstract

A 2017 Willis Towers Watson study of 1 global pension assets covering 22 major pension markets shows a staggering total of US$36,435 billion in pension assets with the U.S. and the U.K. accounting for close  to 70% of these assets. While this total demonstrates a high degree of participation in the accumulation of  assets intended for retirement, the U.S. and U.K. markets for voluntary individual immediate life annuities are small relative to other financial investment outlets competing for retirement savings. The relatively small  size of voluntary immediate life annuity markets is called the “annuity puzzle” because their size seemingly contradicts Yaari’s (1965) assertion that, under certain conditions, utility maximizing retirees should annuitize  all of their wealth upon retirement. The main explanations for the annuity puzzle adverse selection (i.e., the  longevity risk), bequestmotives, and fear of health shocks. Because insurers fear annuitants livingwell beyond  their life expectancy, voluntary immediate life annuities are priced in a manner that make them unattractive  to the general retiree population. One annuity product that is attractive the general retiree population is a  so-called enhanced (substandard or impaired life) annuity that partly solves the problem of  adverse selection. 

Enhanced annuities are medically underwritten to provide greater annual benefits to those with shorter than  average life expectancy. Unfortunately, enhanced annuities do not tackle the problem of long term care due  to medical shocks during the retirement years. We will develop a hybrid annuity called a doubly enhanced  annuity that protects against adverse selection, provides a long termcare benefit, and satisfies a bequestmotive through a death benefit. 

Keywords and phrases: annuity puzzle, long termcare, adverse selection, bequestmotives, doubly enhanced annuity.

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