International Adverse Selection in Life Insurance and Annuities

This paper evaluates the extent of adverse selection in life insurance and annuities in international markets. We examine the extent of adverse selection in group and individual life insurance. In addition we also compare results with prior analyses of adverse selection in international annuity markets, focusing on the US, UK and Japan. Our results may be used to assess the extent to which life insurers can hedge mortality exposure by writing both life insurance and annuities, and to determine a normal range for adverse selection in international insurance markets. David McCarthy Insurance and Risk Management Department The Wharton School, 3641 Locust Walk Philadelphia PA, 19104-6218 e-mail: [email protected] T: 215.898.3589 F: 215.898.0310 Olivia S. Mitchell (corresponding author) International Foundation of Employee Benefit Plans Professor of Insurance and Risk Management Executive Director, Pension Research Council The Wharton School, 3641 Locust Walk, Rm. 304 CPC Philadelphia PA, 19104-6218 e-mail: [email protected] T: 215.898.0424 F: 215.898.0310 PRC http://rider.wharton.upenn.edu/~prc/prc.html IRM http://www.wharton.upenn.edu/wharton/insrdept.html International Adverse Selection in Life Insurance and Annuities David McCarthy and Olivia S. Mitchell 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. Theory predicts that in the absence of insurance company underwriting, adverse selection will improve the mortality (i.e. increase the life expectancy) of annuity purchasers, but worsen that of purchasers of other life insurance products relative to the general population. We explore the difference between mortality tables for this group in the United States, the United Kingdom, and Japan. Many other countries in the Americas, in Europe, and in Asia use either the US or UK tables to value annuities and insurance. Somewhat surprisingly, our results indicate that