Comments on THE ANNUITY MARKET IN AN EVOLVING PENSION SYSTEM: LESSONS FROM ITALY Giovanni Guazzarotti and Pietro Tommasino May 2008 by Laura Piatti* Cerp, Financial Security in Retirement, Collegio Carlo Alberto, Moncalieri (Turin), 18/19 Sept 2008 *IntesaSanPaolo/Turin University

2 The paper: Describes the key characteristics of the Italian annuity market in an international perspective Presents new evidence concerning annuity prices in Italy and computes indicators of actuarial fairness which have been already used in other research (MWRs) Shows that annuities sold on the Italian markets are quite expensive with respect to the ones sold in other countries with a more developed market Advances some policy and market implications to increase efficiency and to speed-up the development of the market

3. General points: Annuities markets around the world are small They have been growing with the increase of DC pension schemes Some previous research shows that MWRs are high in most countries (James, 2001; Mitchell, Mc Carthy 2003) but quite often insurance companies cover their costs through up front pricing and financial portfolio techniques (they earn a spread on the ALM) The pension or asset decumulation/withdrawal is not yet a strategic or commercial issue both for insurers and for distributors (retail markets) There are key market and regulatory factors that explain the low supply and also the low demand for annuities Insurance companies do not manage so efficiently the demographic mutuality (they do prefer the financial one) and returns are quite low (the smaller the market for annuities, the higher is the risk and the spread/price, but total returns remain very low). Annuities or withdrawal plans represent for a distributors an outflows of assets, while as investment products are mostly illiquid and transferable with high costs for the consumers For consumers who would prefer to accept an investment risk and capture the spread themselves (sometime underestimating the longevity risk), the demand for annuities decreases

4. The Italian annuity market (from the paper, confirming other research): Is at present quite underdeveloped Has been not particularly pushed or pulled as the public pension system has been based mainly on a PAYGO scheme and has crowed-out the private market Can be in the future much more developed because of the new rules regarding the payout phase of the public system and for the expected growth of the complementary system Considering the MWR analysis, presents fair prices covering the component due to the cost of adverse selection, but it shows very high prices if referred to the administrative costs and profits components. OBSERVATION: probably this second component also discounts the distribution costs (very high in Italy, see mutual funds and other insurance products) Therefore, supplies products quite expensive (compare to the international experience), with a range of offer very limited and poor solutions for coping with the presence, on the demand side, of a huge bequest motive and a preference for liquid assets OBSERVATION: a working field for market providers could be looking for a wider variety of solutions/products that can deal with the decumulation need, with not only traditional longevity options. In the foreign markets, eg, VA and financial decumulation plans are quite widespread

5 Example: Variable Annuities can be presented as unit-linked with a dynamic allocation of different financial options Unit-Linked + GMDB GMAB GMIB GMWB Guaranteed minimum death benefit Guaranteed minimum allocation benefit Guaranteed minimum income benefit Guaranteed minimum withdrawal benefit Description In case of death, guarantee of a fixed capital higher than the premia paid (also possible during the accumulation period) Guarantee of a minimum return at fixed dates, for example after 5/10/15 years (accumulation period) Guarantee of a minimum level of payouts as life annuities -minimum floor of calculation of the life annuity predetermined in the contract -predetermined switch of the lump sum in a life annuity in the contract Guarantee of a minimum withdrawal value, independent from the effective value of the assets (either for a fixed period of time or for the whole length of the contract)

6 Variable Annuities can cover main risks more widely than other products Key issues: portfolio techniques, risks quotation, administrative costs, fiscal incentives, transparency, regulation. Variable annuities can cover key risks more widely than other products

7 Initial financial capital Lump sum at 80 years Financial annuity with rate of return Initial Insurance capital Differed annuity Annuity Financial component (market risk) Insurance component (longevity risk) eg 80 years There is a no interruption between the financial and the insurance annuity Total Invested Capital Another way to look at the “decumulation” need: From the Asset Management industry: investment + insurance Key issues: good service, financial efficiency to be valued, price