Market Discipline in the Individual Annuity Market

Abstract

Theoretical expectations related to market discipline generally suggest a positive relationship between firm financial strength and price. We examine market discipline in the individual annuity market by measuring annuity contract yields during the accumulation phase and find that, among other results, firm financial strength is positively related to yield (i.e., negatively related to price). We argue that this apparent anomaly can be viewed as a form of market discipline itself, for at least four related reasons, the foremost reason being that in order to compete in the asset accumulation market, an insurer has an incentive to provide a track record of historically strong credited interest rates within the annuity. In addition, the credited interest rates within an annuity are only revealed ex-post over time, thus diminishing consumer ability to impose traditional market discipline relating firm financial strength and price, and also enabling financially weaker insurers to impose higher ex-post prices in the form of lower realized annuity yields.

Keywords: Market discipline, life annuities, guaranty fund, suitability

JEL Classification: G22, G28, G33