Are annuities expensive enough?

(Jun 8, 2009)

The rationale of any business is to make a profit.  This is usually achieved by selling things for more than they cost to make or supply.  The annuities business is no different: an insurer in the UK will typically charge around 5% more than it expects the annuity to cost.  The twist is that it takes many years to find out how much profit is actually made (or if any profit was made at all).

Of course, mortality is a random process as no-one can say for sure when an annuitant will die.  This means that the profit on an annuity is also a random variable.  Figure 1 shows the probability distribution of the profit on a level annuity payable annually in advance to a male aged 60.

Figure 1. Probability distribution of discounted profitů

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Tags: annuities, profit

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