Estimating International Adverse Selection in Annuities

Olivia S. Mitchell, PhD and David McCarthy, FFA

Abstract — It is well known that purchasers of annuities have lower mortality than the general population. Less widely known is the quantitative extent of this adverse selection and how it varies across countries. This paper proposes and applies several methods for comparing alternative mortality tables and illustrates their impact on annuity valuation for men and women in the US and the UK. Our results indicate that the relatively lower mortality among older Americans who purchase annuities is equivalent to using a discount rate that is 50-100 basis points below the UK rate for compulsory annuitants, or 10-20 basis points lower than the UK rate for voluntary annuitants. We then draw on the mortality experience of over half a billion lives to estimate mortality differentials due to varying degrees of adverse selection controlling for country, gender, and an allowance for mortality improvements. Results show that adverse selection associated with the purchase of individual annuities reduces mortality rates by at least 25% in the international context. We also find that the system of mortality tables used to value Japanese annuities is quite distinct from international norms.