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

Overview of Voluntary Pension System

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

Annuity Market and Need for Annuity

Products

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

Annuity Products Types and Additional Benefits

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

Challenges for Insurance Companies

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

Future interest rates unknown, reinvestment risk high

Future inflation unpredictable and indexed bonds unavailable; price-indexed annuities not credible

Companies may expand now, problem could show up later – long term planning is essential