Abstract
Insurance specialists recognize that well-functioning insurance markets – in the form of both life insurance products and annuities – are necessary to ensure effective funded retirement systems and efficient national saving. This is because annuities play an essential role in converting asset accumulations into a regular flow of retirement income guaranteed for life, and classical life insurance protects individuals and their dependants from the risk of early death. But as actuaries know, it takes a great deal of statistical information on mortality patterns by age and sex to develop the necessary survival forecasts needed for valuing annuity and insurance products. And in practice many countries lack a vital statistics collection mechanism, especially for insured lives and annuitants, causing analysts there to rely on mortality data from other countries in order to value insurance products of all types. This paper uses data from three relatively well-developed insurance markets to analyze the differences between the mortality of individuals who have purchased non-annuity insurance products and the general population in these countries. Comparison with previous results permits a comprehensive picture of the effects of adverse selection on mortality and hence on valuation of insurance products in these three markets.
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Notes
- 1.
For additional background see Bowers et al. (1986).
- 2.
Smoothing is usually necessary to eliminate random statistical fluctuations from the data. The theoretical justification behind smoothing is that, as true underlying mortality is expected to change smoothly as age changes, the raw estimate of mortality at age x provides information not only about the true level of mortality at age x but also at ages close to x.
- 3.
In the UK, actuaries assume that mortality improvements are constant across product types, and fit an age-dependant model of mortality improvements to a historical database of tables. This model is used to predict future improvements.
- 4.
This actually happened in the late 1980s when many insurance companies loaded their insurance rates (but not their annuity rates!) for the expected impact of AIDS.
- 5.
Cawley and Philipson (1999) present convincing evidence that insurance companies are better at identifying mortality risk than individuals. Their findings are consistent with our conclusion.
- 6.
In this analysis, the dependence of the price an individual is offered on the extent of adverse selection is ignored. Finkelstein and Puterba (1999) examine this case in the UK annuity market. In extreme cases, this dependence can cause markets to fail. See Akerlof (1970) for more details.
- 7.
Since different insurance products fulfil different needs, policyholders who purchase different products may need to differ in other ways (such as risk aversion, tax status, search costs) in order for this assumption to hold.
- 8.
This effect becomes less important the more cash values of policies deviate from economic values. However, in the presence of borrowing constraints, individuals with serious illnesses may surrender policies to pay for medical care, mitigating this effect to some extent.
- 9.
The tables used in the annuity portion of this investigation are those used by Mitchell and McCarthy (2001) in their investigation of adverse selection in annuities.
- 10.
In the annuity section of the investigation, the tables used are identical to those used by Mitchell and McCarthy (2001) in their investigation of adverse selection in annuities.
- 11.
See James and Vittas (1999). Often actuarial adjustments are applied to these tables, ostensibly to make them more reflective of local conditions. Lacking good mortality data, however, it is difficult to know what actuarial adjustments might be appropriate.
- 12.
This is probably true for the UK and US data; we have no information about possible biases introduced into Japanese mortality tables by the method of construction.
- 13.
There is very little difference between UK Term/Whole Life and Select/Ultimate Tables, partly because of the short select period in the UK. Hence only Whole Life Ultimate tables are shown.
- 14.
To control for changes in population mortality over time, the annuity A/E metrics are reported relative to a base population table from the same time that the data for the annuity tables were collected. These population tables differ slightly from the population tables used to calculate the life insurance table metrics due to mortality improvements over the time between the life insurance data were collected and the time the annuity data were collected.
References
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McCarthy, D., Mitchell, O.S. (2010). International Adverse Selection in Life Insurance and Annuities . In: Tuljapurkar, S., Ogawa, N., Gauthier, A. (eds) Ageing in Advanced Industrial States. International Studies in Population, vol 8. Springer, Dordrecht. https://doi.org/10.1007/978-90-481-3553-0_6
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