Chapter 3-Life Insurance Products (Annuities)

Question 1

Describe in detail the core structure of an immediate annuity contract

Answer 1

Pays regular benefit, provided insured alive at time of payment

Payments start immediately, no deferred period

Purchased by single premium, may actually be proceeds of another policy (e.g. endowment policy)

Customer needs:

• convert capital into lifetime income e.g. pension protect level of future income
• remove uncertainty of how quickly captial should be spent
• may be compulsory requirement

Normally no surrender value because of anti-selection risk (but can be sold to secondary market in some jurisdictions)

Predominantly without-profits or index linked (but can be with-profits and unit-linked versions).

Impaired life annuities sometimes available - higher levels of annuity benefit.

Group version can be used by employer to fund for pensions

Other features:

• May be in advance or arrears
• May be single, joint-life first death, last survivor
• May be level or variable e.g. fixed increase or inflation link
• May have guaranteed period or return of balance of premium on death
• Can be payable for temporary periods only e.g. pay school fees

Question 2

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

Answer 2

Without-profits

With-profits

Index-linked

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

Answer 3

Longevity risk, including rate of improvement of life expectancy

Anti-selection risk: extent depends on extent of free choice available regarding purchase

• those most likely to buy an annuity are individuals who are in reasonably good health (less active form of anti-selection than TA)

Investment risk - extent depends on extent of matching of annuity payments with suitable assets in market and shortage of appropriate securities to match/meet liabilities

Expense risk - all fture expenses have to be met from the single premium (expense reserve)

• higher than expected inflation
• inability of management to manage expenses
• higher than expected initial expenses when selling

Withdrawal risk if withdrawal is permitted (and if there is a benefit on withdrawal)

Question 4

Comment on the capital requirements surrounding immediate annuities

Answer 4

Depends on relationship between reserving/pricing basis

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

Answer 5

Pays regular benefit, provided life insured is alive at time of payment

Benefit payments start at end of deferred period, provided the life insured is alive at vesting date.

Funded by regular (p to vesting date) or single premiums

Customer needs:

• Can be used to build 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)
• may be eligible for certain concessions (tax)

Typically surrender value payable during deferred period, but not normally once benefit starts/is in payment.

Group version exists (employers for their employees)

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 (if reasonable surrender values are given on the endowment). (Note: what are the disadvantages of endowment + immediate annuitiy)

Question 6

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

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
• Additional risks if annuity conversion terms are guaranteed

Question 7

State the capital requirements for a deferred annuity

Answer 7

As for an endowment in so far as convering the lump sum benefit:

• will vary according to the pattern of death benefits provided during the deferred period

Additional capital required to cover any guaranteed terms for converting between a lump-sum and pension