Stochastic assessment of special rate annuities in a value-based perspective

Standard life annuities are generally more attractive to healthy individuals, and their premium rates are therefore relatively high, reflecting the longer life expectancy associated with good health conditions. To stimulate demand in the annuity market and broaden providers’ portfolios, special-rate life annuity products have been developed and introduced in some markets, offering rates tailored to individuals’ health status. More favourable annuity rates are typically offered to individuals in poorer health. However, the pricing and underwriting process introduces a greater degree of heterogeneity through the definition of different risk classes, potentially weakening the pooling effect.The present research aims to examine the impact on the provider’s business value of extending a life annuity portfolio to include special-rate life annuities. Numerical evaluations are conducted using a stochastic approach that accounts for both mortality dynamics and the uncertain effects of heterogeneous lifetimes. From a value-based perspective, particular attention is devoted to assessing the value generated by a larger risk pool, despite the increased heterogeneity.