The Refinancing Enhanced Annuity Rider (REAR): A Novel Annuity Product Design and Its Contribution to Solving the Annuity Puzzle

Colin M. Ramsay, Victor I. Oguledo and Annika Krutto

North American Actuarial Journal, 2025, vol. 29, issue 3, 758-790

Abstract: This article addresses a longstanding problem facing most U.S. retirees: how to protect themselves from longevity risk. An early “solution” to this vexing problem was provided in 1965 by Yaari, who stated that expected utility-maximizing individuals without a bequest motive should fully annuitize their wealth in order to protect themselves from longevity risk. Nevertheless, in practice, individuals with or without bequest motives seldom fully annuitize their wealth, hence the so-called annuity puzzle. In contrast to Yaari’s result in 2015 Reichling and Smetters proved that it may not be optimal for individuals to annuitize any part of their wealth if their life expectancy can be negatively impacted by random health shocks with correlated out-of-pocket health care costs. At the heart of their argument is the fact that when random health shocks reduce the actuarial present value (APV) of an annuitant’s future annuity income stream, the value of nonannuitized wealth is unaffected by these health shocks, making the optimal level of annuitization less than 100%. Inspired by Yaari’s and Reichling and Smetters, seemingly conflicting results, we have created a novel single premium immediate annuity (SPIA) product called a refinancing enhanced annuity rider (REAR) that is intended to resolve this conflict by combating the potentially significant reduction in APV due to health shocks. The REAR is an innovative annuity feature that gives an annuitant who has experienced a reduced life expectancy owing to health shocks the right (option) to use her policy’s reserves on a specified date to “refinance” her annuity, that is, purchase a new enhanced (substandard) annuity, to increase her annual annuity income stream over her reduced expected future lifetime. To prevent adverse selection, a REAR must be purchased before the start of the annuity’s decumulation phase. To date, no similar product exists in the global life annuity market. We anticipate that our novel refinancing idea will unlock some of the vast annuity reserves to the benefit of annuitants, thus leading to an expansion of the global annuity market.

Date: 2025
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DOI: 10.1080/10920277.2025.2454454

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