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Status, Importance and Measures for Development of Annuity Products after Introduction of Voluntary Pension System
Javed AhmedPresident, Pakistan Society of Actuaries
Overview of Voluntary Pension SystemAnnuity Market and Need for Annuity
ProductsAnnuity ProductsChallenges for Insurance Companies
Presentation Summary
VPS operates under the VPS Rules notified by the SECP
Aims to encourage post-retirement savings through tax advantages encouraging competitionmaking necessary products/saving vehicles
availableFlexibility provided through portability of benefits
and options available at retirement
Pre-Retirement Period Post-Retirement Period
Retirement
Investment Withdrawals Charges Administration Unit Pricing Trustees Market Conduct
Retirement Age : 60 – 70 years On onset of defined disability deemed to be retired Options available on retirement
Purchase of annuities through life insurance companies
Key Aspects of Pre and Post Retirement Periods in VPS
Post-Retirement Period Converting assets into income in orderly manner
increasingly important for ageing population Importance of structures available at retirement:
Post-retirement period may be as long or longer than the pre-retirement period
Investment strategy for retirement income is a delicate and critical issue
Greatest risk faced by those saving for retirement is outliving their assets
Options Available at Retirement in VPS
1. Cash + AnnuityWithdraw up to 25% of individual pension account as cash and use remaining amount to purchase annuity from life insurance company of choice
2. Cash + Income Drawdown + AnnuityWithdraw up to 25% of individual pension account as cash and withdraw monthly installments till age 75 years according to income payment plan. At end of period purchase annuity from life insurance company of choice
Practical Limitations on Pension Options
Many can not defer vesting due to immediate need for post-retirement income
General tendency is to withdraw maximum cash allowed as lump sum
Income drawdown attractive option; however, arguably only for the affluent
Financial Planning Challenge
No one knows how long he/she will live. This leads to difficulty that people may:Outlive their assets, and die in povertyRestrict their living standard needlessly and die
excessively rich
No one knows what will be the investment returns in future.
Annuity SolutionSolution to the financial planning challenge is
to insure against longevity, passing the risk to the insurer
Annuities take large premium and turn it into fixed income stream until death providing insurance against longevity and investment risk
Many types with added protection and cost
Problems in Annuity Market Perceptions - Belief that annuities are poor value for
money Products - Lack of products that match consumer needs
for income flexibility Processes - Inadequate distribution and marketing
processes Politics - Withdrawal of tax advantages in subsequent
years Liquidity and Flexibility - People want liquidity and
flexibility for emergencies, bequest for family if they die early
Section 18(3) VPS Rules states“The annuity purchased may be single life, joint or survivor life, level (with or without guarantee period), increasing, investment-linked and retail price index linked or with any additional features as may be offered by the Life Insurance Companies”
Life Insurance Companies need to develop competitive annuity products to cater for the consumer needs
Type of AnnuitiesConventional AnnuitiesEnhanced/Lifestyle AnnuitiesImpaired Life AnnuitiesFlexible AnnuitiesWith-profit AnnuitiesInvestment-Linked Annuities
Conventional AnnuitiesSafest type of annuity for retireeGuaranteed income regardless of
investment conditions and life spanMedical examination would generally not
be requiredDownside - locked into the annuity rate
prevailing at the time - if the interest rates improve in future, retiree will miss out
Enhanced/Lifestyle AnnuitiesEssentially a conventional annuity paying
enhanced annuity rate because life expectancy may be shorter due to lifestyle or state of health
Some medical examination would be required
May be eligible if suffering e.g. from diabetes, liver condition, cancer etc.
Impaired Life AnnuitiesBasically a conventional annuity, but
rates enhanced dramatically due to significantly reduced life expectancy
Typically retiree would have less than 5 years to live
Usually requires full medical underwriting
Flexible AnnuitiesAllows flexibility in levels of incomeContains investment element, which adds to
complexityExample - rolling 5 year annuity
Premium for annuity divided into two portions: one for investment and other for purchase of temporary annuity for 5 years, with option to renew for another 5 years at the end of each 5 years or buying a life time annuity
With-profit AnnuitiesPays bonuses based on performance of
the fundBonuses are smoothedAllows participation in investment
returns, whilst giving smoothed income stream
Investment Linked AnnuitiesPension fund capital is invested in
insurance company’s own managed investment fund
Similar to with-profit annuities but there is no smoothing effect to income stream
Income is derived from disposal of units, and because they can vary in value, income will vary
Additional BenefitsAdditional benefits can be added to annuity
packageCost of additional benefits is reflected in
annuity rates being offeredExamples of additional benefits
EscalationJoint and Survivor PensionPayment Guarantee Period Income Frequency
Mortality tables for population don’t exist
Annuitants are select group with higher longevity
Future mortality improvements unknown; likely to be high
Long term financial instruments not available resulting in asset/liability mismatch risk