fatvegan

One of the problems with life annuities is they are trying to provide insurance, and to smooth out income. And providing that sort of insurance is super hard. I'd tell annuities to go suck an egg, but if you want private superannuation you kind of need them. I want to know if there's a role for annuities that aren't insurance, but provide a neat way of smoothing income. At the moment annuities are inequitable because rich people end up getting a lot of the money that the poor throw in, and unappealing because no-one wants to give their retirement money to other people if they can help it.

The other problem is that insurance companies need to give us much less than they really should just in case we accidentily all end up living until 90. Insuring a whole nation against the possibility of everybody living an extra 10 years is, and always will be impossible to insure against. Insurance works using the law of large numbers and spreading out risk across large numbers of people. But it only works if there is a reasonable sort of average that the insurance company can figure out ahead of time. If everyone is dying later and later, then the average is a moving target, and the law of large numbers is not so useful. So if this is happening our only options are to ask our kids for more money or reduce our expenditure. Neither of these options are related to annuities at all. The age pension provides the first option, and takes money from the young and gives it to the old if they need it for some reason.

So I've blathered on about what that was. But my idea is to let insurance companies update their expectations as time goes on. Insurance companies should be able to use additional information about the population and individuals as it becomes available. So if you have cancer so they give you a great deal on your annuity, but then you are cured, they should be able to reduce your yearly payment.

I did some fiddling in Openoffice, and made this. The expectations are initially that the person will live for 15 more years but they end up living for 25 years. The jitters in the tapered income line represent points where the insurance company readjusts their expectations of how long the fellow is going to live for. With the flat annuity, either the poor old chum runs out of money at 79, or the insurance company has to pay out. I haven't done a very good job of accounting for growth in the capital base. I've assumed 3% real growth, but that isn't really what's important.

Does anyone have any ideas about how to stop insurance companies from abusing this system? You'd probably need some sort of transferability between companies to ensure competition. Or perhaps they sell you an income formula instead of an income quantity when you first buy the annuity. There could be some independent institution responsible for working out average and individual life expectancies and the insurance companies could be forced to use those estimates perhaps.