Demand and adverse selection in a pooled annuity fund

Abstract

In this paper, we construct a model for examining the demand for annuities together with the possible implications of adverse selection when an individual consumer has access to both a private annuity market and a market with a pooled annuity fund. An earlier paper by Piggott et al. [Piggott, J., Valdez, E.A., Detzel, B., 2005. The simple analytics of a pooled annuity fund. J. Risk Insur. 72, 497–520] provides a formal analysis of the payout adjustments from a longevity risk-pooling fund, an arrangement referred to in the paper as Group Self Annuitization (GSA). In such a pooled arrangement, the annuitants will bear their own cohorts’ systematic risk, but the cohort will share the idiosyncratic risk. The resulting return on the pooled annuity fund can be expressed as the product of a return from an ordinary annuity multiplied by a random variable that accounts for the adjustment that is due to deviations from expectation of mortality and investments. As demonstrated in this paper, a simple analysis of economic choice provides that it is possible to reduce the implications of adverse selection in a pooled annuity fund. It is well-documented that empirically, individuals do not find private annuity funds an attractive form of investment despite the potential welfare benefits that can be drawn from annuitization. A pooled annuity fund is an alternative to the conventional private annuity fund that may be considered more cost-effective.