Over the next several years, some 77 million Baby Boomers are poised to stop working and start receiving public pensions, throwing the pay-go pension system out of balance as fewer workers must support more retirees. One does not need a crystal ball to recognize that public pension benefits will have to be severely cut or taxes increased substantially, to ward off the collapse of that system. At the same time, these Boomers have accumulated a private pension retirement nest egg worth trillions of dollars, and they now need advice on how to draw down their lifetime savings so as not to run out of money. This book reviews a wide range of private pension income solutions on offer by the US insurance industry, called life annuities. In particular, the author analyzes how variable annuities can work to help protect against longevity risk.
The author starts with an explanation of the core trade-offs involved when deciding on variable income annuities versus self-directed retirement plans. The essence of the argument is that annuities provide a means to insure against mortality risk and offer income lasting a lifetime, while self-directed retirement drawdown strategy exposes the retiree to the risk of running out of savings. On the flipside, a self-directed retirement plan allows full control of assets, while the purchase of an annuity is irrevocable. The author then goes on with a more technical discussion of the mechanics of several annuity payout options. The pricing and risk/return profiles of variable income annuities are explained very clearly, so that readers without deep actuarial knowledge will understand their key features. Nevertheless, the more mathematically-inclined reader will not be disappointed, as numerical illustrations support the key points.
A very long chapter on “Annuitant Populations and Annuity Present Values” is much more technical, dealing with actuarial mathematics, mortality models, and pricing of annuities. Those already acquainted with the theory of population modeling and mortality table estimation will definitely enjoy the background information about determinants of mortality improvement, recent aging theories, and the author's smoothly interwoven anecdotes. A technical derivation of pricing formulas for more advanced annuity products (e.g. multilife annuities, last survivor annuities or contingent annuities) is also useful. Dellinger then turns to asset allocation within the funds (so-called subaccounts) underlying the variable annuity, where he notes that the consumer of a variable annuity has full control over the asset allocation of the subaccounts (similar to a mutual fund investment). Thus, modern portfolio management tools can be applied to manage the assets underlying the variable annuity. He also analyzes the rate of return of variable annuities from the consumer's viewpoint. In addition to the return on the underlying assets in the instrument, the consumer also earns an extra return called “survivorship credit.” This additional return is backed by the redistribution of funds of ceased former pool members.
The author also takes on the risks that insurance companies take on, when offering variable annuities. Real world risk factors as well as regulatory requirements on reserves and risk based capital are presented and discussed in depth. Taxes applicable to annuitants and costs in form of service fees are also detailed. Of great interest is the detailed discussion of the potential market size for variable annuities, the distribution chain for the product, and underwriting techniques. He shows how indexes can provide consumers an easy and transparent means to benchmark across annuity products. Substandard underwriting, or clustering annuity clients into finer classes than just age and gender, might be practical to retrieve the advantages of price discrimination and to introduce more adequate risk capital assessment. The book continues with a detailed exploration of legal issues applicable to variable annuity providers, a brief discussion of different forms of insurance, and an investigation of the potential business value of offering variable annuities. A final chapter discusses recent product development trends in variable income annuity markets. The author explores the use of payout floor guarantees in a pure Black/Scholes world and summarizes the real-world risks associated to multi-decade hedging of payout floor guarantees. Furthermore, he evaluates products which enhance the liquidity or accessibility of funds placed into a variable annuity. Also the possibility of mortality risk securitization is explored which would allow insurance companies to transfer mortality risks to the capital market. A final conclusion recapitulates factors that could foster or limit the growth of variable annuity markets.
In all, this book is a brilliant source for information on almost every facet of variable annuity markets in the US. The author also shares his professional expertise in actuarial, personal investment, industry, taxation, and legal fields. His intent is to provide clear understanding of key features of variable annuities, as he argues they could become the answer to secure the standard of living for millions of retirees. Dellinger's clear language, numerous well directed mathematical illustrations, and richness of empirical facts, contribute to a comprehensive picture of variable annuities. Actuaries, mathematicians, and finance professors can benefit from reading it, as it employs financial and actuarial mathematics to achieve a deeper insight into variable income annuities. Financial advisors, policymakers, and pension fiduciaries can also make use of the book as a valuable guide to support their policies and recommendations. Insurance professionals could also use this book to gain an improved judgment of the liability side of variable income annuities. Speaking investment parlance, the book is a great investment for anyone interested in individual retirement security solutions.
