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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

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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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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?

UNSW Research Symposium 2 November 9, 2006

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Supply challenges to the provision of annuities Purcal

Overview

1. Motivation
2. Literature
3. Australia
4. U.S.A.
5. U.K.
6. Germany

UNSW Research Symposium 3 November 9, 2006

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Supply challenges to the provision of annuities Purcal

2 Literature

Introduction
Risk management issues

– Interest rate risk – Longevity risk – Adverse selection

Alternatives to annuities

UNSW Research Symposium 4 November 9, 2006

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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

UNSW Research Symposium 5 November 9, 2006

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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

UNSW Research Symposium 6 November 9, 2006

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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

UNSW Research Symposium 7 November 9, 2006

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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.

UNSW Research Symposium 8 November 9, 2006

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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

UNSW Research Symposium 9 November 9, 2006

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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).

UNSW Research Symposium 10 November 9, 2006

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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.

UNSW Research Symposium 11 November 9, 2006

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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

ther financial instruments—brings default risk.

UNSW Research Symposium 12 November 9, 2006

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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.

UNSW Research Symposium 13 November 9, 2006

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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

UNSW Research Symposium 14 November 9, 2006

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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