GOOD PRACTICE IN REGULATING ANNUITY

PROVIDERS

Chris Daykin

UK Government Actuary

STRUCTURE FOR ANNUITY BUSINESS

• authorise only specialist providers, or…• …treat as a class of insurance business• ring-fence annuity business in separate fund?• requirements should be at least equivalent to

those for insurance business• sound and prudent management standard

PRINCIPLES OF SUPERVISION

• fit and proper persons to manage and control• licensing and authorisation• financial monitoring - assets and liabilities• safety margins and intervention mechanisms• marketing conduct and disclosure• managing insolvency and guarantee fund(?)

CONTROLS ON PRODUCT

• best practice is not to control premium rates• …in order to enhance competition• emerging annuity markets might need controls • …controls on product itself for consistency• price controls to ensure adequate rates• …and to avoid naïve competition

SUPERVISION OF ASSETS AND LIABILITIES

• appropriate provision for liabilities• appropriate asset valuation • prudent investment strategy • relationship between assets and liabilities• corresponding capital requirements

FRAMEWORK FOR PROVISIONS

• traditional prudent reserving approach• static or dynamic valuation framework• fair value of assets with consistent provisions• fair value of assets and liabilities• mismatch provision…• … or additional capital requirements

RESERVING ASSUMPTIONS

• mortality• rate of interest• expenses• asset/liability mismatching• reinsurance recoveries• other assumptions

MORTALITY

• nature of annuitant population• implications of selection• voluntary or mandatory system• options, e.g. programmed withdrawal• future improvement• prudent margins

EXPECTATIONS OF LIFEMALES - PROJECTED TO 2031

Age ELT15 2011 2031(1991) (projected) (projected)

0 73.4 76.9 78.520 54.5 57.4 59.040 35.3 38.4 39.960 17.9 20.4 21.780 6.4 7.3 8.1

RELATIVE VALUES OF ANNUITIES - MALES

Age ELT15 Pop. Mort. PML92 PMA92with impt. (C=2010) (C=2010)

60 100 109 111 11665 100 110 112 11870 100 108 111 11875 100 107 111 11780 100 105 109 114

RATE OF INTEREST

• prudent assumption about yields secured (real or nominal rates)

• cautious reinvestment rate to reflect uncertainty

• fair value framework uses term structure corresponding to current market conditions

• discount rate might be corporate bond rate

MISMATCH RISK

• key risk for annuity provider• adequacy of assets is sensitive to yields• must have bonds of sufficient duration• …and of wide spread• immunisation techniques available• …or require dynamic financial analysis

IMMUNISATION

Select asset portfolio such that

Value of assets = Value of liabilities

Mean discounted duration of assets

= mean discounted duration of liabilities

Spread of discounted asset proceeds

> spread of discounted liability flows

EXPENSES

• provide future costs of running off liabilities• …without any reliance on new business• allowance for inflation• reserve for costs of closing down

DYNAMIC FINANCIAL ANALYSIS

• cash flow testing of assets and liabilities• deterministic or stochastic• sensitivity testing• identification of weaknesses• development of risk control strategies

APPOINTED ACTUARY

• continuous appointment• assets as well as liabilities• continuous financial monitoring• hot line to supervisor• responsibilities to company and supervisor• duty to the profession

CAPITAL REQUIREMENTS

• solvency margin régime• capital requirement related to risk• depends on margins in assets/provisions• structured intervention possibilities• last resort might be compensation fund…• …but creates risk of moral hazard

WIDER IMPLICATIONS

• mismatching implies higher reserves…• …or higher capital requirements• higher reserving impacts on pricing• wide range of suitable assets needed• annuity business needs to be self-supporting• danger of concentration of risk in industry

MODERN REGULATION

• freedom with publicity• no prior controls of products or premiums• fair valuation requirements (coming IASB standard)• risk-based capital requirements• professional responsibility for financial condition• transparent intervention mechanisms• dynamic financial analysis• close supervisory monitoring (including on-site)

QUESTIONS AND DISCUSSION?

Expectation of life based on mortality experienced in years 1900 to 1992 and

projected to 2030

EXPECTATIONS OF LIFEFEMALES - PROJECTED TO 2031

Age ELT15 2011 2031(projected) (projected)

0 79.0 81.5 83.320 59.7 61.8 63.540 40.2 42.3 43.960 22.1 24.0 25.680 8.4 9.0 10.1

COMPARISON OF ANNUITY VALUES - MALES

Age ELT15 Pop. Mort. PML92 PMA92with impt. (C=2010) (C=2010)

60 11.1 12.1 12.3 12.965 9.5 10.5 10.6 11.270 8.0 8.6 8.9 9.475 6.5 6.9 7.2 7.680 5.2 5.4 5.6 5.9

COMPARISON OF ANNUITY VALUES - FEMALES

Age ELT15 Pop. Mort. PFL92 PFA92with impt. (C=2010) (C=2010)

60 12.7 13.6 13.4 13.765 11.2 12.0 11.9 12.270 9.7 10.1 10.2 10.675 8.1 8.4 8.5 8.980 6.4 6.6 6.8 7.2

RELATIVE VALUES OF ANNUITIES - FEMALES

Age ELT15 Pop. Mort. PFL92 PFA92with impt. (C=2010) (C=2010)

60 100 107 105 10865 100 106 106 10970 100 104 105 11075 100 104 105 11180 100 103 105 112

RESILIENCE (STRESS) TESTING

• range of adverse scenarios• future mortality improvement• expense overrun scenarios• interest rate changes• asset default• market fluctuations• resilience reserves in technical provisions