Academic journal article Journal of Risk and Insurance

Longevity Risk Management in Singapore's National Pension System

Academic journal article Journal of Risk and Insurance

Longevity Risk Management in Singapore's National Pension System

Article excerpt

ABSTRACT

Although annuities are a theoretically appealing way to manage longevity risk, in the real world relatively few consumers purchase them at retirement. To counteract the possibility of retirees outliving their assets, Singapore's Central Provident Fund, a national defined contribution pension scheme, has recently mandated aunuitization of workers' retirement assets. More significantly, the government has entered the insurance market as a public-sector provider for such annuities. This article evaluates the money's worth of life annuities and discusses the impact of the government mandate and its role as an annuity provider on the insurance market.

INTRODUCTION

While defined contribution (DC) pensions have enjoyed varying degrees of success during the accumulation phase, proponents of the DC model now confront the larger question of how participants will manage their capital throughout the payout phase so as not to run out of money in retirement. Not surprisingly, governments have become involved in this decision, as in the case of Switzerland where annuitization is the default payout modality; given a choice, most retirees elect to annuitize (Butler and Teppa, 2007). The United Kingdom has a long history of annuitization for those holding private DC pension accounts, yet retirees have substantial leeway over how much to annuitize and when (Finkelstein and Poterba, 2002, 2004). And in Chile, workers have long been given a choice between phased withdrawal and annuitization when they claim their pensions (Mitchell and Ruiz, Forthcoming).

In contrast to such flexibility over annuitization, the Central Provident Fund (CPF) of Singapore has recently announced that retirement assets held by its citizens in the national DC plan must be mandatorily annuitized so as to better protect retirees against the possibility of outliving their wealth. At the same time, the government has decided to enter the insurance market as a provider for these annuities. This article evaluates the money's worth of privately offered annuities prior to the reform, discusses the impact of the government mandate, and assesses how the entry of the government as an annuity provider is shaping the nation's insurance markets. Our results are of interest for several reasons. First, the CPF is widely acknowledged as one of the world's largest--and arguably most successful--DC schemes. Accordingly, it is valuable to see how this system is handling the challenges of a rapidly aging population. Second, we seek to determine whether market failure--that is, low value-for-money annuities--prompted the government to enter the insurance market as an annuity provider and whether the new government-offered annuities will provide greater value to retirees.

We show that competitively priced life annuities were offered by private insurers in Singapore prior to the reform, with money's worth ratios (MWRs) in the 0.88-1.05 range for males--on par with those in many other countries. Moreover, adverse selection costs were reasonable, on the order of 3.3-5.6 percentage points. The new government-offered annuities are estimated to provide MWRs exceeding unity, benefiting annuitants on average but also implying that the annuity mandate will be expensive for the government if current pricing continues.

These findings are relevant to the current debate about how to best deploy annuities to manage longevity risk within the context of a DC scheme. On the positive side, mandating annuitization can reduce loads and adverse selection and can help retirees better manage the risk of outliving their income, as detailed by Emms and Haberman (2008) and Horneff, Maurer, Stamos (2008). Yet on the negative side, mandating can also pose challenges. For instance, making annuity purchase compulsory produces utility losses for less risk-averse retirees. (1) Also, if left to private annuity providers, market distortions can arise: for instance, in the United Kingdom. …

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