Status, Importance and Measures for Development of Annuity Products after Introduction of Voluntary Pension System Javed Ahmed President, Pakistan Society of Actuaries

OOverview of Voluntary Pension System AAnnuity Market and Need for Annuity Products AAnnuity Products CChallenges 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 competition  making necessary products/saving vehicles available  Flexibility 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 + Annuity Withdraw 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 + Annuity Withdraw 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 poverty  Restrict their living standard needlessly and die excessively rich  No one knows what will be the investment returns in future.

Annuity Solution  Solution 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 Annuities  Conventional Annuities  Enhanced/Lifestyle Annuities  Impaired Life Annuities  Flexible Annuities  With-profit Annuities  Investment-Linked Annuities

Conventional Annuities  Safest type of annuity for retiree  Guaranteed income regardless of investment conditions and life span  Medical examination would generally not be required  Downside - locked into the annuity rate prevailing at the time - if the interest rates improve in future, retiree will miss out

Enhanced/Lifestyle Annuities  Essentially 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 Annuities  Basically 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 Annuities  Allows flexibility in levels of income  Contains investment element, which adds to complexity  Example - 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 Annuities  Pays bonuses based on performance of the fund  Bonuses are smoothed  Allows participation in investment returns, whilst giving smoothed income stream

Investment Linked Annuities  Pension 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 Benefits  Additional benefits can be added to annuity package  Cost of additional benefits is reflected in annuity rates being offered  Examples of additional benefits  Escalation  Joint and Survivor Pension  Payment 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