What's Wrong with Annuity Markets?

Abstract

We show that the supply of U.S. life annuities is constrained by interest rate risk. We identify this effect using annuity prices offered by life insurers from 1989 to 2019 and exogenous variations in contract-level regulatory capital requirements. The cost of interest rate risk management---conditional on the effect of adverse selection---accounts for about half of annuity markups or eight percentage points. The contribution of interest rate risk to annuity markups sharply increased after the Great Financial Crisis, suggesting new retirees' opportunities to transfer their longevity risk are unlikely to improve in a persistently low interest rate environment.

Keywords: life annuities; corporate bond market; retirement; interest rate risk; adverse selection

JEL Classification: D82; E44; G22