Ch 3: Life ins prods - Annuities (immediate, deferred)

Question 1

Describe in detail the structure of an immediate annuity contract

(6,1,1,1,2,2,1)

Answer 1

1. Pays regular benefit, provided insured alive at time of pmt
2. Payments start immediately, no deferred period
3. Purchased by single premium, may be proceeds of another policy (e.g. EA)
4. Customer needs
   
   • convert capital into lifetime income e.g. pension
   • protection of income against longevity
5. Normally no SV.
   
   • Anti-selection risk. Poor health surrender when know not recieve many payouts
   • But can be sold or transfered to other providers (pay less to ill health)
6. Group version can be used by employer to provide pensions

Question 2

Additonal features of immediate annuities

8

Answer 2

Other features:
1. May be in advance or arrears
2. May be single, joint-life first death, last survivor
3. May be level or variable e.g. fixed increase or inflation link
4. May have guaranteed/min payment period ==> reduce ann rate(more expensive)
5. Can be payable for temporary periods only e.g. pay school fees
6. Death benefits possible. Dep on competition, Reputational risk
7. Living annuity= Income drawdown not actually an annuity
8. Impaired life annuity: Higher annuity rates avail to reflect lower longevity.

Question 3

What forms may be used to write immediate annuity business (4)

Answer 3

1. Without-profits
2. With-profits
3. Index-linked
4. Unitised
   
   • insurer guarantees paying value of units, income is guaranteed in number of units, but not in monetary value (as price will value)

Question 4

State key risks to an insurance company that arise from immediate annuities

(5 points, 2,3,4,4,1)

Answer 4

1. Longevity risk
   
   • including rate of improvement of life expectancy for prudence
   • Risk of PH living longer than expected. Overest mort rate / under est mort improvement
2. Anti-selection risk:
   
   • Reduce the choice to purchase annuity==> less risk
   • Regulation helps here
   • Poor health lives won’t purchase an annuity.
3. Investment risk
   
   • Poor ALM ==> higher risk
   • Lump sum + inv ret not suff to cover benefit payments + expenses
   • Disinvest lump sum to cover this. Fund =0 at time of death of PH
   • Perfectly match fixed interest for each disinv amt over time and hold to maturity
4. Expense risk
   
   • higher than expected inflation
   • inability of management to manage expenses
   • higher than expected initial expenses when selling
   • All met from single prem, drawdown from fund.
5. Withdrawal/persistency risk may arise if withdrawal is permitted (proof of good health)

Question 5

Comment on the capital requirements surrounding immediate annuities (3)

Answer 5

1. Can be quite significant, as will need to set aside capital to meet a very long term liability purchased with a single premium
2. Depends on relationship between reserving/pricing basis
3. Capital strain if insurer needs to set up reserves and solvency margins higher than single premium received
4. 5 factors are NB

Do Q3.9 numeric eg

Question 6

Describe in detail the core structure of a deferred annuity contract (6)

Answer 6

1. Pays regular benefit, provided life insured is alive at end of deferred period
2. Funded by regular or single premiums payable up to vesting date.
3. Customer needs
   
   • Can be used to buid up to pension in retirement
   • % Lump sum instead of part/all of the annuity
4. Typically surrender value payable during deferred period, but not after vesting date
5. Group version exists (employers for their employees)

Question 7

List ‘other/additional features’ which one might find with such annuities (5)

Answer 7

Features for deferred annuities:
* advance/arrears
* single/joint
* level/variable
* guarantee period
* less flexible than endowment assurance (savings vehicle) with immediate annuity starting at maturity date

Question 8

State the risks to an insurance company that arise from deferred annuities

(1,5)

(2,3)

Answer 8

Split into risks before and after vesting/annuity payments commence:

• Pre-vesting: as for endowment
  
  • investment
  • mortality
  • (depending on death benefit)
  • withdrawal/persistency
  • expenses
• Post-vesting: as for immediate annuity
  
  • longevity
  • investment
  • expenses

Question 9

Comment on the capital requirements surrounding deferred annuities

5 , 1, 1, 1, 3, 1

Answer 9

For lump sum - as for endowment assurance

1. Frequency of premium pmts
   
   1. more upfront = less capital intensive
2. Initial expenses
   
   1. higher initial expenses increase capital requirement if premium doesn’t increase
3. Solvency capital requirements
   
   1. need assets to cover supervisory and required solvency capital
4. Contract design
   
   1. whether contract design allows reserves/solvency margin to remain low
   2. lower initial reseves = lower initial capital requirement
   3. slower increase in reserves over contract term, faster invested capital is release
5. Reserving basis (level of prudence)
   
   1. reserving basis stronger, requires more capital than would be required under pricing basis

Guaranteed terms (for converting between lump sum and pension - requires additional capital