Annuity Markets and Retirement Security

AbstractThe growing importance of defined contribution pension arrangements has drawn increased attention to the means by which retired people draw down their assets. Current UK law requires annuitisation of at least a fraction of defined contribution plan accumulations. Annuity markets have recently attracted some criticism with respect to pricing and the available range of product options. This paper describes a key feature of voluntary annuity markets: the presence of ‘adverse selection’. This is the tendency of annuitants to live longer than non‐annuitants, since individuals who know that they are likely to die soon do not purchase annuities. The paper presents information that quantifies the importance of adverse selection in the setting of private annuity prices and discusses the role of compulsory annuitisation requirements in reducing it. Requiring individuals to participate in the annuity market can reduce selection effects, at the cost of reducing individuals' range of retirement income options.