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

Question 1

Describe in detail the core structure of an immediate annuity contract (7)

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

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 actually be proceeds of another policy (e.g. endowment policy)
4. Customer needs
   
   • convert capital into lifetime income e.g. pension
   • protect level of future income
5. Normally no surrender value (but can be sold to secondary market in some jurisdictions)
6. Group version can be used by employer to provide pensions
7. 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 period
   5. Can be payable for temporary periods only e.g. pay school fees

Question 2

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

Answer 2

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 3

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

(5 points, 6 additional subpoints)

Answer 3

1. Longevity risk
   
   • including rate of improvement of life expectancy
2. Anti-selection risk: extent depends on extent of free choice available regarding purchase
3. Investment risk
   
   • extent depends on extent of matching of annuity payments with suitable assets in market
   • shortage of appropriate securities to match/meet liabilities
4. Expense risk
   
   • higher than expected inflation
   • inability of management to manage expenses
   • higher than expected initial expenses when selling
5. Withdrawal/persistency risk may arise if withdrawal is permitted

Question 4

Comment on the capital requirements surrounding immediate annuities (3)

Answer 4

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

Question 5

Describe in detail the core structure of a deferred annuity contract (7)

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

Answer 5

1. Pays regular benefit, provided life insured is alive at time of pmt
2. Benefit payments start at end of deferred period,
3. Funded by regular or single premiums
4. Customer needs
   
   • Can be used to buid up to pension in retirement
   • Lump sum instead of part/all of the annuity, meeting need for cash sum at that point (e.g. to pay home loan)
5. Typically surrender value payable during deferred period, but not normally once benefit starts/is in payment
6. Group version exists (employers for their employees)
7. Annuity choices as for immediate annuity i.e
   
   • advance/arrears
   • single/joint
   • level/variable
   • guarantee period
   • less flexible than endowment assurance (savings vehicle) with immediate annuity starting at maturity date

Question 6

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

(1,5)

(2,3)

Answer 6

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 7

Comment on the capital requirements surrounding deferred annuities

Answer 7

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