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

Normally no surrender value (but can be sold to secondary market in some jurisdictions)

Group version can be used by employer to provide 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

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

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

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

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,

Funded by regular 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)

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

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