On the Cost of Adverse Selection in Individual Annuity Markets: Evidence From Singapore

Abstract

New evidence is presented on the cost of adverse selection in individual annuity markets using Singapore data. The Singapore annuity market is an interesting setting to examine the cost of adverse selection for three reasons. First, unlike many Western countries, the Singapore government provides very limited public financial assistance for retirees. Second, while social security contributions mandated under the Central Provident Fund (CPF) result in a high forced savings rate, a large proportion of CPF savings, are used up for housing. Third, to ensure that retirees have sufficient funds to meet basic needs, individuals who reach age 55 are required to set aside a minimum amount of their CPF savings, which can be withdrawn at age 62. The CPF Board allows various options for investing the minimum sum, but the most attractive option is to purchase an annuity. The institutional setting in Singapore in effect provides insurers with a large captive market for annuities. It is conjectured that this should be reflected in a significantly lower cost of adverse selection for annuities sold in Singapore as compared with other countries. The results herein, using data for CPF-approved insurers, are strongly consistent with this conjecture. On average, money's worth of annuities is higher than annuities sold to a similar age-gender mix in the United States, United Kingdom, and Australia. Adverse selection accounts for less than 13 percent of the cost of longevity insurance compared to 30-50 percent documented in many previous studies. These results suggest that one way to resolve the adverse selection problem is to adopt a universal individual defined contribution pension scheme that mandates or provides strong incentives for retirees to purchase annuities.

Life annuities of compulsory savings and income adequacy of the elderly in Singapore

“…For example, for the female elderly to secure a monthly payout of $670 under the benchmark scenario, the premium is $84,682 when l=4% and increases to $89,568 when 17 Detailed discussions are given by Doyle et al (2001) and Fong (2002) respectively. 18 Similar monthly payouts computed by other sources using the newly decreed minimum amount of $80,000 effective in July 2003 are not available for comparison.…”

Trading death: The implications of annuity replication for the annuity puzzle, arbitrage, speculation and portfolios

“…This information asymmetry leads to adverse selection in annuity markets, Poterba (2002, 2004), Fong (2002), Friedman and Warshawsky (1990), Mitchell and McCarthy (2002), and Walliser (2000). 15 Not only do annuitants have better information on their life expectancy when they buy an annuity or life insurance (Idler & Benyamini, 1997), but they are more likely to be aware of changes in their life expectancy that occur after the annuity or life insurance has started.…”

Betting on a Long Life – the Role of Subjective Life Expectancy in the Demand for Private Pension Insurance of German Households

“…Most frequently studied are the markets in the US (Friedman and Warshawsky (1990) and Mitchell et al (1999)) and in the UK Poterba (2002, 2004)). Further examinations have been done for Germany (von Gaudecker and Weber (2004)), Australia (Doyle et al (2004)) and Singapore (Doyle et al (2004) and Fong (2002)), as well as for Canada, Chile, Israel and Switzerland (James and Song (2001)). McCarthy and Mitchell (forthcoming) and Rothschild (2009) also compare mortality tables of policyholders with those of the general population, but do not explicitly calculate the money's worth.…”