Inflation Insurance for Australian Annuitants

In the burgeoning market for immediate annuities, products offering payments escalated at a fixed rate of 5% per year have been greatly outselling their 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.