As long as it's purely optional (as with the annuitization of TSP) and only sold to those who understand what they are buying, I have no problem with this provided it's actuarially neutral to the U.S. Treasury. It's not that much different than "trading in" some or all of your 401K for a pension, which may be fine in some cases but the devil is in the details. I just don't want to see annuity sales critters preying on people about to retire and giving a high-pressure sales job.
Put another way, I have no problem with this idea IF it's optional and if there is no aggressive marketing campaign to convince people to annuitize.
My concern would be a form of "adverse selection" where someone is more likely to take the annuity option when their parents and grandparents all lived to be at least (say) 85, and their payout is based on average life expectancy. In other words, I would expect an annuity to be more attractive to folks with a family history of longevity, and if the payout is based on overall life expectancy this could be a bad deal for the taxpayers.
As far as only 5% of TSP participants taking the annuity -- were CSRS folks ever in the TSP or was that only for FERS people? I would imagine CSRS retirees would feel less need to "annuitize" any TSP balances because the defined benefit pension under CSRS was likely generous enough to not need "buying" any more pension benefit. I could be wrong but I would imagine more FERS retirees would be interested in annuitizing their TSP than CSRS retirees would be.