IIS 44th Annual SeminarThe Life Insurance Market’s Response to Aging:

Mega or Mini?

Gustavo Ferro

Universidad Argentina de la Empresa (UADE) and CONICET (gferro@uade.edu.ar)

Taipei (Taiwan), July 16th, 2008

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Introduction

• Aging implies more savings for retirement, worldwide

• In a competitive and complex environment:– What piece of the retirement market will be provided by

insurers?

– Can we expect a “Mega” or “Mini” response of the industry?

– Keeping in mind that “Insurance is sold, not bought”, who are the relevant counterparts?

• We propose some answers to these questions in this presentation

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Outline of this “policy paper”

• Introduction

• Aging

• Demand-side

• Supply-side

• Regulation

• Proposals

• Conclusions

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Aging

Average life expectancy at birth

Source: Jousten (2007) on World Population Prospects: The 2004 Revision Highlights, United Nations 2005

75.6

82.1

63.4

74.0

60

65

70

75

80

85

90

2000-2005 Forecast 2045-2050

More developed regions Less developed regions

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World: 65.4

World: 75.1

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Demand-side, current state

• From Pay-As-You-Go Defined-Benefit systems towards Fully-Funded Defined-Contribution schemes.

• Variety of reforms

• In 2006, assets of pension funds in OECD countries accounted for US$ 24.6 trillion (72.5% of the GDP)

• Few annuities are voluntarily purchased

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Demand-side, looking ahead

• The accumulation phase of pension funds will soon be followed by a decumulation phase

• Tax provisions could influence non-optimal options that are currently selected by retirees, such as:

– Lump sum, Phased withdrawals

– “Rules of thumb” for investing and withdrawing

• Why not annuititize? – relevant discussion issues– Adverse selection

– Perception of “expensive” premiums

– Bequest motive

– Precaution savings for long-term care

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Supply-side: Money Worth Ratios

0.7 0.8 0.9 1.0 1.1 1.2

General population Annuitant population

MWR on nominal (immediate single payment) annuities – Male, 65 MWR using public bond rate

0.7 0.8 0.9 1.0 1.1 1.2

MWR using corporate bond rate

Australia

Canada

US

UK

Switzerland

Source: Mackenzie (2002)

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Supply-side facts

• Only an annuity provides longevity insurance

• However, MWRs reveal adverse selection and few countries have developed annuity markets

• There are market and regulatory responses and innovative “prototypes” of annuity contracts

• Factors that could yield an extended market include:

– Better mortality data and regulated mortality tables

– Public sector involving in their development

– Mandatory annuitization at some age

– Innovative contracts

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Regulation

• Based on market failure perspective

• Intended “to protect people who cannot easily protect themselves”

• Prudential regulation and opposite risks

• Mandatory annuitization?

• Tax provisions could induce annuitization

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Proposals for insurance industry

• Departing from an analogy of the three pillars for pensions of the World Bank

• Multi-Tier Insurance Package for the Pensioners’ Saving Decumulation Phase (MIP)

First Tier

Allowed Lump-Sum Decumulation

Second Tier

Third Tier

Phased Withdrawalin sub accounts (“Lockboxes”)

Annuitization by an “Annuiplus” purchase

Voluntary Mandatory

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Multi-Tier Insurance Package For the Pensioners’ Saving Decumulation Phase (MIP) First Tier Second Tier Third Tier Name Allowed Lump-Sum

Decumulation Lockboxs’ Phased Withdrawal

Mandatory Annuitization by ‘Annuiplus’ Purchase

Character Voluntary Voluntary Mandatory (voluntary deferrement)

Resources Gross Savings Net Savings (Gross Savings – Lump Sum)

Lockboxes (Net savings +/- investment yields in Second Tier)

Output Lump sum Phased Withdrawal (Locked in “Boxes” –subaccounts-)

Annuiquest, or Annuicare, or Annuicarequest, or a classic Annuity

Rationale Free disposal of an ammount of money

To increase resources and to preserve liquidity. Subject to investment risk.

To smooth consumption avoiding moral hazard. To leave a bequest. To afford high long-term care expenses.

Proposed Tax Treatment

As income of the period As income of the period for increases in the value of the shares in each period.

No taxation for the death and care insurance payments. As income of the period for annuities payments

Source: Author’s elaboration.

MIP concept in detail

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Hypothetical example

Calculations for illustrative MIP-Bundles (basis: US mortality and MWRs)

0 50 100 150

Lump sum + Immediate Annuiquest

Total cost

Lump sumat 65 ($15,000)

Death insurance at 65 ($10,000)

Immediate annuity, from 65 ($9,562 p.a.)

Costs in thousands US$

0 50 100 150

Lump sum + Deferred Annuiquest

Total cost

Lump sumat 65 ($15,000)

Death insurance at 65 ($10,000 p.a.)

Deferred annuity, from 70 ($9,562 p.a.)

Phased withdrawal

Costs in thousands US$

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Conclusions

• The “Mini” scenario (reactive response) implies risk of little business and low margins

• (One) “Mega” Scenario is proposed to raise the industry’s awareness among politicians, regulators, international organizations and pensioners

• It tries to cover demand-side needs and to be appealing to politicians, regulators and international organizations looking for financial stability

Thank you for your attention

gferro@uade.edu.ar

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Appendix 1: Aging

Life Expectancy at Birth, present and future Area 2000-05 2045-50

World 65.4 75.1 More Developed Regions 75.6 82.1 Less Developed Regions 63.4 74.0

Source: Jousten (2007) on World Population Prospects: The 2004 Revision Highlights, United Nations 2005

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Appendix 2: Money Worth Ratios

MWR for a group of countries on nominal annuities (immediate single payment life annuities) Australia Canada Switzerland UK US General population

Annuitant population

General population

Annuitant population

General population

Annuitant population

General population

Annuitant population

General population

Annuitant population

Male 65, using public bond rate

0.914 0.986 0.925 1.014 0.965 1.169 0.897 0.966 0.816 0.916

Female 65, using public bond rate

0.914 0.970 0.937 1.015 1.029 1.152 0.910 0.957 0.829 0.893

Male 65 using corporate bond rate

0.846 0.906 0.869 0.947 0.922 1.104 0.854 0.916 0.742 0.825

Female 65 using corporate bond rate

0.839 0.885 0.874 0.941 0.974 1.083 0.860 0.901 0.745 0.797

Source: Mackenzie (2002).

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Appendix 3: An hypothetical example

MIP in action: calculations for US mortality and MWR values. Bundle

(Lump Sum + Immediate Annuiquest since 65) Bundle

(Lump Sum + Deferred Annuiquest since 70)

Component Cost US$ Component Cost US$ Lump sum at 65 (US$ 15000) 15000

Lump sum at 65 (US$ 15000) 15000

Death Insurance at 65 (US$ 10000) 5657

Death Insurance at 65 (US$ 10000) 5657

Immediate Annuity since 65 (US$ 9562 a year)

129343

Deferred Annuity since 70 (US$ 9562 a year) 82066

Phased withdrawal 0 Phased withdrawal 47278 Total 150000 Total 150000