Designing Annuities with Flexibility Opportunities in an Uncertain Mortality Scenario

Abstract

We consider annuity designs in which the benefit amount is allowed to fluctuate (up or down), based on a given mortality/longevity experience. This way, guarantees are relaxed in respect of traditional annuity arrangements. On the other hand, while the annuitant is exposed to the risk of a future reduction of the benefit amount because of higher longevity, he/she can immediately take advantage of a lower premium loading, as well as of a future increase of the benefit amount in the case of higher mortality. Flexibility in the annuity design could be welcomed by individuals, as the conservative features of traditional products partly explain their lack of attractiveness in most markets. To further contribute to the flexibility of the product, we suggest a pricing structure based on periodic fees applied to the policy fund, instead of the usual upfront loading at issue. Periodic fees are more suitable to support a revision of the arrangement after issue, which is currently not allowed in traditional annuity products. We show that periodic fees can be introduced by identifying a discount factor to be used for pricing and reserving. We assume stochastic mortality, and we compare alternative mortality/longevity linking solutions, by assessing the periodic fees and other quantities.