The determinants of mortality heterogeneity and implications for pricing annuities

Ramona Meyricke and Michael Sherris

Insurance: Mathematics and Economics, 2013, vol. 53, issue 2, 379-387

Abstract: Standard annuities are offered at one price to all individuals of the same age and gender. Individual mortality heterogeneity exposes insurers to adverse selection since only relatively healthy lives are expected to purchase annuities. As a result standard annuities are priced assuming above-average longevity, making them expensive for many individuals. In contrast underwritten annuity prices reflect individual risk factors based on underwriting information, as well as age and gender. While underwriting reduces heterogeneity, mortality risk still varies within each risk class due to unobservable individual risk factors, referred to as frailty. This paper quantifies the impact of heterogeneity due to underwriting factors and frailty on annuity values. Heterogeneity is quantified by fitting Generalized Linear Mixed Models to longitudinal data for a large sample of US males. The results show that heterogeneity remains after underwriting and that frailty significantly impacts the fair value of both standard and underwritten annuities. We develop a method to adjust annuity prices to allow for frailty.

Keywords: Mortality heterogeneity; Frailty modelling; Annuity pricing; Longitudinal data; Generalized linear mixed models (search for similar items in EconPapers)
JEL-codes: C23 G22 G23 (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (9)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:insuma:v:53:y:2013:i:2:p:379-387

DOI: 10.1016/j.insmatheco.2013.06.002

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