1. ¹Centre for Research in Applied Macroeconomics, University of Bristol, UK
2. ²Xfi Centre for Finance and Investment, University of Exeter, UK

^*This research was funded by the ESRC "Understanding the Evolving Macroeconomy" Programme under grant L138 25 1031. We should like to thank Becca Fell, Alexa Hime and Sally Lane for entering the data and Pensions World for assistance in obtaining back copies. We should like to thank David Blake, David De Meza, Tim Leunig, Mike Orszag, Laura Piatti and David Webb for helpful comments; any remaining errors are the authors' own.

Abstract

This paper constructs a time series of annuity rates in the U.K. for 1957–2002, and examines the pricing of U.K. annuities, and the relationship between the accumulation and decumulation phases of a defined contribution pension scheme by focusing on the properties of the pension replacement ratio. The paper computes the money's worth of annuities over the sample period, and finds that on average the money's worth has been just less than unity, implying that annuities are fairly priced. Using data on annuity returns and the returns on other financial assets, the paper simulates replacement ratios, to build up a frequency distribution of the pension replacement ratio for a U.K. individual. These frequency distributions illustrate the risk in the pension replacement ratio faced by an individual who saves in a typical defined contribution pension scheme.