A Primer on Annuities: What Economists and Financial Professionals Need to Know about Variable Annuities, Fixed Indexed Annuities, and Registered Index-Linked Annuities
Both academic economists and financial professionals emphasize the value of annuities for households that need to manage risks during retirement. Yet the risks that each focuses on, and the types of annuity products that economists versus professionals consider to be the best way to manage those risks, are vastly different. Academic economists almost exclusively consider traditional income annuities as a tool to eliminate longevity risk, even though income annuities are quite rare in the real world. Financial professionals offer a range of products that have annuity or annuity-like components or options, combined with additional features that help households manage investment and, in some cases, long-term care cost risk. These complicated financial products may not be fully understood when financial professionals are offering advice to individuals who are considering purchasing them, and they are rarely analyzed by academic economists. Consequently, the goal of this primer is twofold: first, to incorporate the features of real-world annuity products into economic models, with the goal of stimulating academic research; and second, to elucidate the economic consequences of real-world annuity products for financial professionals, with the goal of facilitating an appropriate match of product features to household needs.
Academic economists are familiar with income annuities, in which households pay an irrevocable sum of money to an insurer in exchange for a lifetime income starting immediately or, less commonly, at some fixed future date. Many economists have investigated the value of income annuities as a mechanism for managing longevity risk and have puzzled over the quite low holdings of such annuities in the real world. However, income annuities—whether they are the traditional variety where income commences immediately or the recently introduced deferred variety where income commences at some future date, normally when the retiree is at an advanced age—comprise only a small share of the annuity market.