Insight: Value for Money and Prudential Regulation of Annuities
By Edmund Cannon and I. Tonks
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Cannon and Tonks (2016) evaluate different lifetime annuity products in the United Kingdom using the money’s worth (MW), which is a measure of value for money (VfM). They confirm that the MW is lower for back-loaded annuities than it is for level annuities. That result is consistent with the theory of adverse selection and has been used as evidence that adverse selection is present in annuity markets; it may also explain the fact that few people purchase annuities voluntarily, a phenomenon known as the annuity puzzle. Cannon and Tonks (2016) show that back-loaded annuities are associated with more risk (and hence higher cost) for annuity providers because a higher proportion of their present values are paid in the future where there is greater uncertainty, which provides an alternative explanation for differences in the MW. Using the Lee and Carter (1992) mortality model (discussed below) to quantify the importance of this effect, Cannon and Tonks (2016) show that it is not possible to identify whether there is adverse selection in annuity markets.
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About the Authors
Edmund Cannon is Professor of Economics in the School of Economics at the University of Bristol.
Ian Tonks is Professor of Finance in the School of Accounting and Finance at the University of Bristol. Both authors have written extensively on pension economics, savings, and annuity markets.