Buying a fixed level annuity exposes a retiree to which of the following risks: (i) Bomb out (ii) Investment (iii) Inflation?

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Multiple Choice

Buying a fixed level annuity exposes a retiree to which of the following risks: (i) Bomb out (ii) Investment (iii) Inflation?

Explanation:
Fixed level annuity payments stay the same in nominal terms for life, so inflation steadily reduces their real value. The insurer bears the investment risk and the longevity risk in a standard life annuity, so those risks aren’t borne by the retiree with a fixed payment. Therefore, the retiree’s main remaining risk is that inflation erodes purchasing power over time. This makes inflation the only relevant risk for a fixed level annuity.

Fixed level annuity payments stay the same in nominal terms for life, so inflation steadily reduces their real value. The insurer bears the investment risk and the longevity risk in a standard life annuity, so those risks aren’t borne by the retiree with a fixed payment. Therefore, the retiree’s main remaining risk is that inflation erodes purchasing power over time. This makes inflation the only relevant risk for a fixed level annuity.

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