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Inflation Insurance for Australian Annuitants
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Andrew Formica and Geoffrey Kingston
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Abstract
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In the burgeoning market for immediate annuities, products offering payments escalated at a fixed rate of 5% per year have been greatly outselling the CPI-indexed counterparts, thanks to the lure of high early payments. Modifying recent analogies between inflation insurance of annuity streams and sequences of call options on synthetic CPI futures, we estimate the cost of insuring fixed-escalation annuity streams against prespecified drops in purchasing power. With such insurance, annuitants could enjoy reasonably high early payments without risking an inordinately low standard of living after some years of sustained high inflation, or towards the end of a long life.
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Keywords
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ANNUITIES; OPTIONS; CPI.
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Contact Details
Andrew Formica
AMP Society
1-3 Alfred Street
Circular Quay NSW 2000
Geoffrey Kingston
Department of Economics
University of New South Wales
Kensington NSW 2033
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Thanks are due to the AMP Society, especially Michael Bath, Bill Dowsley and Craig McLean, for assistance with this project. The Australian Research Council also provided assistance. Helpful discussions on aspects of this project were had with Hazel Bateman, Jeff Carmichael, Jack Frisch, John Piggott and Mike Sherris. Lance Fisher assisted us with CPI data. Zvi Bodie gave us encouraging feedback on an earlier draft. Two referees made useful suggestions. Responsibility is confined to the authors.
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