Book reviews for The Journal of Pension Economics and Finance reflect reviewers' own views and in no way represent the views of the institution(s) with which they are affiliated.
Annuities provide insurance against outliving one's wealth that ought to be valued by risk-averse households facing an uncertain lifespan. Yet, both in the US and elsewhere, only a small proportion of households voluntarily annuitize any of their wealth. Many factors are likely to contribute to households' reluctance to annuitize. High on most researchers' lists would be households' lack of understanding of longevity risk and the potential benefits of annuitization, the impact of adverse selection on annuity prices, and the fact that most currently retired households have high proportions of their wealth pre-annuitized through Social Security and defined benefit pension plans. Looking ahead, however, lower Social Security replacement rates and the displacement of defined benefit pension plans which typically paid life annuities, may stimulate the demand for private annuities. Accordingly, Mackenzie's scholarly and comprehensive survey of the economic and regulatory issues relating to private annuity markets is particularly timely.
His volume begins with an excellent summary of the existing literature on why the demand for annuities is currently so limited. The truth is that the lack of demand is something of a puzzle, and this makes it somewhat difficult to determine whether, and in what manner, governments should intervene to influence households' retirement asset decumulation choices. He then investigates the supply side of the annuity market, highlighting two significant risks faced by annuity providers: the risk that annuitants may, on average, live longer than expected, and interest rate risk arising from the lack of ultra-long dated bonds. In my opinion, the solution may be for insurers to transfer both of these risks to the annuitant. From the annuitant's point of view, uncertainty about his own longevity is a far greater source of risk than uncertainty about aggregate mortality risk, while many potential annuitants may be willing to retain investment risk in exchange for higher expected returns.
The book goes on to outline alternative regulatory models for both annuity investments and reserves. It then turns to international experience with individual accounts, with particular emphasis on the decumulation phase. It covers the Chilean experience in some detail, but also outlines reforms in other Latin American countries and Eastern Europe. Next the author examines the reasons for restricting withdrawals from retirement accounts and more specifically, for mandating at least partial annuitization. He argues that the case is stronger for accounts that replace PAYG Social Security systems than for accounts that form part of a second tier, and he makes the case for ‘libertarian paternalism’ in relation to the second tier – encouraging, but not compelling, annuitization. Mackenzie points out that those individuals who lack self control in financial matters, and who recognize that fact, may actually welcome restrictions on their behavior. Yet he omits to mention an important argument for mandatory annuitization, namely that it can reduce the effects of adverse selection, benefiting all except those who would prefer not to annuitize even at the more favorable rates made possible by compulsion.
In the last section, the author proceeds from the premise that at least some restrictions on withdrawals from individual accounts are desirable, and he then considers what form those restrictions should take. Here the author omits an important issue, namely the potential for even modest rates of inflation to wreak havoc with the income provided by a fixed nominal annuity over what for many households may be a 30-year retirement. It is also perhaps too dismissive of variable annuities. If, as some argue, there are advantages to postponing annuitization to benefit from the equity premium, then households ought to be even better off with a product that offers both the equity premium, and mortality credits. Mackenzie then explains how one might calculate the impact of mandatory annuitization of individual account balances on annuity prices. He outlines a variety of not-wholly-satisfactory techniques for hedging the risk that annuity rates might be particularly unfavorable at the time a household comes to retire, and he considers the thorny question of whether insurance companies should be permitted to discriminate between male and female purchasers. It rounds off with considerations of issues surrounding government guarantees of insurance company solvency, and the taxation of income from annuities. The final chapter concludes with a checklist of the issues that those considering introducing or reforming a system of individual accounts should consider. This, of course, begs the wider question of whether and to what extent the provision for retirement income should be rebalanced away from pay-as-you-go programs. But enough has perhaps been written on that particular subject already.
This well-written book deserves a place on the bookshelves of economists and especially policy advisers interested in pension reform and annuity markets. The work is suitable for a general audience, as equations have been consigned to a comprehensive mathematical appendix.
