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Author: intercst Big funky green star, 20000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 17953  
Subject: Re: Constant Average Interest Rate Date: 2/22/2001 10:02 PM
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greygreen writes,

The assumption is a constant 3% per annum adjustment for COL. That's a good clarifying question. If you want a "truly indexed" product, it will be a bit more expensive where the distribution of annual inflation rates is skewed with a heavy right tail. However, constant inflation assumption is the manner in which such products are generally priced.


Thanks for the clarification.

There was an interesting article on this subject in the Sept/Oct 1999 issue of Contingencies "Now Is the Time for True Annuities", Zinzow, Lee A. pp. 54-59. Mr. Zinzow (one of your fellow actuaries) described his analysis in purchasing his own annuity. He decided to go with a 6% COLA (which of course greatly reduced the first year's annuity payment) since that's what he felt he needed to protect himself against runaway inflation. It seems to me that you could price an annuity indexed to the CPI to offer a larger initial benefit that a straight 6% COLA since an average inflation rate of 5.41% per annum is the highest we've seen (as measured by the CPI) for a 30-year holding period over the past 130 years.

intercst
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