Supply challenges to the provision of annuities Sachi Purcal School of Actuarial Studies University of New South Wales Sydney, Australia November 2006 E-mail: s.purcal@unsw.edu.au
Supply challenges to the provision of annuities Purcal 1 Motivation Ageing populations—annuity is a highly engineered product containing guaranteed protection over several dimensions of risks Work done on the demand for annuities; what about supply side? What are the supply constraints facing LICs offering annuity products? What risk management issues are involved with this line of business? 2 UNSW Research Symposium November 9, 2006
Supply challenges to the provision of annuities Purcal Overview 1. Motivation 2. Literature 3. Australia 4. U.S.A. 5. U.K. 6. Germany 3 UNSW Research Symposium November 9, 2006
Supply challenges to the provision of annuities Purcal 2 Literature • Introduction • Risk management issues – Interest rate risk – Longevity risk – Adverse selection • Alternatives to annuities 4 UNSW Research Symposium November 9, 2006
Supply challenges to the provision of annuities Purcal 3 Australia Small market for life annuities (only $27 million last year). Annuity risk managment Interest rate risk: Lack of quality long term debt —particularly indexed debt Longevity risk: Feel can reasonably manage this. Reinsurance no longer available. Currency risk 5 UNSW Research Symposium November 9, 2006
Supply challenges to the provision of annuities Purcal 4 U.S.A. Size of market misleading • $301 billion flowed into annuities in 2004 • largely tax-sheltered deferred annuities, most won’t be annuitised • probably $2–3 billion annuitised each year 6 UNSW Research Symposium November 9, 2006
Supply challenges to the provision of annuities Purcal Annuity risk management Good supply of long dated bonds Widespread feeling an adequate allowance has been made for longevity risk 7 UNSW Research Symposium November 9, 2006
Supply challenges to the provision of annuities Purcal U.K. Largest market for immediate life annuities in the world • Annual new business premiums of £ 9 billion • Driven by compulsory annuitisation of tax-efficient DC personal pension plans Bulk purchase business growing ( £ 3 billion last year) • Annuity contracts bought by trustees of DB pension schemes • Forecast strong growth in this and above Occupational schemes clearly important—many problems recently. 8 UNSW Research Symposium November 9, 2006
Supply challenges to the provision of annuities Purcal Lifetime annuities Standard palette—also: With profits pension annuity • Participate in company’s With-Profits Fund • Customers exposed to investment/survivorship profits/losses • Pseudo inflation protection? • Guaranteed minimum • Customers ‘anticipate’ a bonus rate • Small sales (2%), but strong growth in 2005 (30–50%) • No cash value 9 UNSW Research Symposium November 9, 2006
Supply challenges to the provision of annuities Purcal Lifetime annuities Impaired annuity available and becoming popular. View that pricing will become more sophisticated than just f ( age, sex, investment size ) . 10 UNSW Research Symposium November 9, 2006
Supply challenges to the provision of annuities Purcal Annuity risk management Mix of cash flow matching, duration matching plus interest rate swaps (and other derivatives) to manage cashflow/duration mismatch down to acceptable levels. Adequate supply of long dated fixed interest investments important. Deferred business more of a problem—strong growth in bulk annuity market. • managing interest rate risk more difficult: liabilities of longer duration • need much more long dated investment instruments Inflation protection expensive—shortage of long nominal/indexed paper. Inflation swaps. 11 UNSW Research Symposium November 9, 2006
Supply challenges to the provision of annuities Purcal Longevity risk Actuarial profession has come a long way recently in understanding it, but still area of great uncertainty. Reinsurance is available, but difficult to obtain. Not much support for ‘natural hedging’. Credit risk Substantial degree of investment in corporate bonds and other financial instruments—brings default risk. 12 UNSW Research Symposium November 9, 2006
Supply challenges to the provision of annuities Purcal Other issues Substantial capital required to write this line of business. • actuarial reserves plus 4% solvency margin • plus risk-based capital assessment Longevity bonds. Product innovation. 13 UNSW Research Symposium November 9, 2006
Supply challenges to the provision of annuities Purcal 5 Germany Very different • participating (with profits) annuity is standard • some evidence of level life annuity Strong growth (1998–2004) in total annuity payouts (14%) • reductions in public pension payments • tax incentives to save in private pension plans Endowment insurance still most popular retirement savings vehicle 14 UNSW Research Symposium November 9, 2006
Supply challenges to the provision of annuities Sachi Purcal School of Actuarial Studies University of New South Wales Sydney, Australia November 2006 E-mail: s.purcal@unsw.edu.au
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