Optimal risk classification with an application to substandard annuities

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<title>Optimal risk classification with an application to substandard annuities</title>
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<namePart>Gatzert, Nadine</namePart>
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<abstract>Substandard annuities pay higher pensions to individuals with impaired health and thus require special underwriting of applicants. Although such risk classification can substantially increase a companys profitability, these products are uncommon except for the well-established U.K. market.In this paper we comprehensively analyze this issue and make several contributions to the literature.First, we describe enhanced, impaired life, and care annuities, and then we discuss the under writing process and underwriting risk related thereto. Second, we propose a theoretical model to determine the optimal profit-maximizing risk classification system for substandard annuities.Based on the model framework and for given price-demand dependencies, we formally show the effect of classification costs and costs of underwriting risk on profitability for insurers.Risk classes are distinguished by the average mortality of contained insureds, whereby mortality heterogeneity is included by means of a frailty model. Third, we discuss key aspects regarding a practical implementation of our model as well as possible market entry barriers for substandard annuity providers.</abstract>
<note type="statement of responsibility">Nadine Gatzert, Gudrun Schmitt-Hoermann, Hato Schmeiser</note>
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<title>North American actuarial journal</title>
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<publisher>Schaumburg : Society of Actuaries, 1997-</publisher>
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<identifier type="issn">1092-0277</identifier>
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<text>03/12/2012 Tomo 16 Número 4  - 2012 </text>
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