Beyond Age and Sex: Enhancing Annuity Pricing
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Prices of standard annuity products in the United States do not currently reflect buyers’ personal characteristics other than age and sex. I show that several readily-measurable risk factors can significantly increase explained variability in mortality outcomes in a proportional hazards framework and use them to construct alternative pricing schemes. Simulation results show that more detailed pricing may help reduce adverse selection in annuity markets because shorter-lived groups are made much better off (and thus enter the market) while longer-lived groups are made only slightly worse off (and thus remain in the market).
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Fong is a doctoral student and S.S. Huebner Foundation Fellow at the Wharton School, University of Pennsylvania. All opinions are solely that of the author who acknowledges research support from the Pension Research Council/Boettner Center at The Wharton School. Without implicating them, I would like to thank Irma Elo, Dean Foster, Benedict Koh, Jean Lemaire, Olivia S. Mitchell, Greg Nini, Samuel Preston, Yong Yu, and participants in the BPUB 900 seminar at The Wharton School for their valuable comments and discussions. I am indebted to Jeff R. Brown and Olivia S. Mitchell for use of the code for generating utility-equivalent wealth values. All errors are my own. Please direct correspondence to hfong@wharton.upenn.edu.