Transcript INFORM +INSPIRE - The Griffith Foundation

INFORM+INSPIRE
Life Insurance and
Annuities
R. B. Drennan, PhD
Temple University
August 20, 2011
The Griffith Insurance Education Foundation
Life Numbers…

How long will
you live?



Life Expectancy At Birth
What is “life
Year
expectancy”?
Males/Females 1850
Today: M / F
Female
Male
40.5
38.3
1900
51.1
48.3
1950
71.7
66.0
The Griffith Insurance Education Foundation
2
Mortality: Nature of the Loss
(Premature Death)
Meaning-- “Death with outstanding
unfulfilled financial obligations”
 Costs




Loss of earnings to family (Human Life Value)
Final expenses (Liquidity Issue)
Non-economic costs
 Emotional loss, role models
Causes of death among young (~20)

CA, S, OA, C
The Griffith Insurance Education Foundation
3
Life Numbers…

Probability of death for 20-35 year-old:

In U.S.:


X out of 1,000
$100,000 of LI coverage:




F*S
.001 * $100,000 = $____
$1 per $1000 of face amount
Price for pure protection
The Griffith Insurance Education Foundation
4
Term Life Insurance Pricing
mortality
curve
(~term)
$
or
p(l)
x
time
The Griffith Insurance Education Foundation
100
5
Term Versus Permanent Pricing
mortality
curve
(~term)
$
or
p(l)
under
payment
level
premium
overpayment
x
time
The Griffith Insurance Education Foundation
100
6
Life Insurance Products
 Traditional




Term Life
Whole Life
Endowment
Annuities
 Non-Traditional




Universal Life
Variable Life
Variable Universal Life
Variable Annuities
The Griffith Insurance Education Foundation
7
Life Insurance Rate (Price)
Development

Mortality Experience and Rating Factors




Age (group 20 and 60 year-olds?)
Male / Female
Smoker / Non-Smoker
Race?

Unique Factors: Hobbies, Job, Foreign Residence

Loading (Net Rate vs Gross Rate)





Expenses
Taxes
Contingencies
Profit
Interest (Long-term contract)
The Griffith Insurance Education Foundation
8
Objectives in Insurance Prices
(Rates)

Adequate

The payments generated by a block of policies plus any
investment return on same must be sufficient to cover
current / future benefits and costs
Equitable (not “unfairly” discriminatory)



Refers to setting premiums commensurate with expected
losses and expenses; also suggests no cross
subsidization. Sets a floor.
Not Excessive



Sets a ceiling
Competition
Regulation (FL catastrophes)
The Griffith Insurance Education Foundation
9
Solvency Policing

Statutory Accounting ( A = L + Surplus )

Minimum Capital and Surplus Requirements

Annual and Quarterly Financial Statements

Audited Statements Required

Statements Signed by an Actuary

Company Examinations


Every 3 to 5 years
Coordinated within zones
The Griffith Insurance Education Foundation
10
Solvency Policing

Investment Restrictions


Type, quality, and quantity
Insurers typically match assets and liabilities

Minimum Reserve Requirements

Solvency Monitoring





Insurance Regulatory Information System (IRIS)
FAST – Financial Analysis Solvency Tools
Risk-Based Capital Requirements
Ratings (Best, S&P, Weiss)
Holding Company Issues
The Griffith Insurance Education Foundation
11
Consumer Protection

Product and Price

Rate criteria
(not inadequate, not excessive, not “unfairly” discriminatory)


Types of rating laws
 Prior approval
 MLR in health insurance
Policy forms (products)

Underwriting

Agents and Brokers
The Griffith Insurance Education Foundation
12
Consumer Protection

Unfair Trade Practices



Rebating, Twisting vs. Replacement
Market Conduct Examinations
Policy Forms - Contracts

Definition of key terms




Grace period
Incontestability Clause
Surrender values
Reinstatement
The Griffith Insurance Education Foundation
Annuities
•Oscar Wilde:
–“…It is better to have a permanent income than to be
fascinating.”
The Griffith Insurance Education Foundation
14
The Risk
We’ve worked and saved $1 million
The Risk: We might live a (really) long
time and outlive our assets
W.B.’s goal:
In most countries:






65-year-old men and women can expect to live to 81 and
85
1/3 women and 1/5 men born today will live beyond 90
The Griffith Insurance Education Foundation
15
How Long
Will
Retirement
Assets
Last?
The Griffith Insurance Education Foundation
16
Life Insurance vs. Annuities

Think of as opposite of LI


Life insurance addresses the risk of dying too
soon—mortality risk
Annuities address the risk of living “too
long”—longevity risk
The Griffith Insurance Education Foundation
17
Life Insurance vs. Annuities



Over 50% of Life Insurer premiums today
are for annuities instead of LI—why the
shift from when they were only 25%?
Basic Idea is: For every $100,000, 65year-old can receive ~$700 in monthly
income ($8,400 per year), for life.
Now, women receive more or less than
men? And why?
The Griffith Insurance Education Foundation
18
Annuities Defined

Life Annuity





In return for a single premium or a series of
premiums
Provides a series of periodic payments to a named
person
Starting at a specified date (now or later)
For life
…People always live forever when there is any
annuity to be paid to them. Jane Austen
The Griffith Insurance Education Foundation
19
Purpose of Annuities

Purpose: to provide an income that cannot
be outlived


Insurer takes on longevity risk and investment risk
Annuitant / Payee takes on risk of dying too soon


Live to 104, good deal; Die in 6 months, not so good
Insurer not so concerned with poor health
of applicants for annuities
The Griffith Insurance Education Foundation
20
One Product, Two Stages:
A Deferred Stage, Then an Immediate Stage
Annuitization
(conversion from
deferred to
immediate stage)
Source: Black and Skipper, Life & Health Insurance, 13th edition,
(Upper Saddle River, NJ: Prentice-Hall, 2000) p. 165.
The Griffith Insurance Education Foundation
21
Annuities—Mechanics

Longevity risk is pooled by insurer




Insurer can predict the approximate number of
annuitants who will be alive at the end of each year
Some individuals will live long / short
The unliquidated contributions of those who die
early can be used to provide payments to those who
live a long time – benefit of survivorship
Some people uncomfortable with big “forfeit”—to be
discussed shortly. Thus, few people annuitize, and
even fewer annuitize without some form of
minimum guarantee
The Griffith Insurance Education Foundation
22
Annuity Settlement Options

Cash option—lump sum or in installments for a period
of time
Life annuity (no refund) – provides life income while
annuitant alive; payments end at death




Life annuity w/ guaranteed payments


Highest periodic income
But potential for big forfeiture
Usually 5, 10, 15 or 20 years
In general, monthly benefit is related to risk borne by
annuitant versus insurer
The Griffith Insurance Education Foundation
23
Deferred Annuities,
Classified by Underlying Investment
Deferred
Annuities
Fixed
Traditional
Fixed
Variable
Indexed
The Griffith Insurance Education Foundation
Traditional
Variable
With Guaranteed
Minimum
Benefits
24
Fixed Annuities

Traditional Fixed




Guaranteed ROR at the time of purchase
No investment risk for the purchaser
More safety
Tradeoff – ROR is very modest
The Griffith Insurance Education Foundation
Fixed Annuities

Indexed Annuities




Splits the difference between a fixed and
variable annuity
Fixed guaranteed minimum ROR
Variable ROR tied to S&P Market Index
or some other barometer of investment
growth
Can participate in the market while still
protecting their principal
The Griffith Insurance Education Foundation
Variable Annuities

Traditional Variable


Ties the growth of the annuity to stock
and mutual funds
No guarantees offered by the insurer
The Griffith Insurance Education Foundation
Variable Annuities

Variable with Living Benefit Option




Guaranteed minimum benefits
Guaranteed benefits for life
Guaranteed minimum ROR
Opportunity for a portion of their funds to
be invested at a potentially higher ROR
The Griffith Insurance Education Foundation
Individual Annuity Sales –
2001-2010
The Griffith Insurance Education Foundation
Annuity Regulation
Currently, Who Regulates
What?
The Griffith Insurance Education Foundation
30
States Regulate Fixed and
Variable Annuities
• Annuities are insurance products because,
in their immediate annuity stage, they involve “life
contingencies”
• This means the benefit depends on how long
someone lives
• As insurance products, they are regulated by
the states
• State regulation of annuities covers
• Minimum reserves
• Contract provisions
• Market conduct standards
The Griffith Insurance Education Foundation
31
Currently, the SEC Regulates
Variable Annuities
The SEC considers a variable annuity an
investment, not an insurance product
• Because the annuity owner retains the
investment risk (unlike a fixed annuity, in which
investment risk is transferred to the
insurance/annuity company)
• SEC regulation is in addition to state securities
regulation, but states typically copy SEC
requirements
• SEC regulation of annuities covers
• Market conduct standards
The Griffith Insurance Education Foundation
32
Who Regulates Indexed Annuities?
• Indexed annuities are fixed annuity products
• When interest is credited, the credit is determined by the
annuity company.
• The determination uses a formula that the company can
change.
• The formula uses an external index, often the S&P 500
• As fixed annuity product, they’re currently
regulated by the states
• Even though indexed annuities
• Determine investment growth by reference to a
stock market index, and
• May be sold partly on the “upside potential,”
they’re not currently regulated by the SEC
 This issue is a matter of debate – Rule 151(a)
The Griffith Insurance Education Foundation
33
“Suitability” Issue
• It involves matching
• The customer’s characteristics, future plans for the
policy and related financial matters, the customer’s
circumstances, and
• A policy’s characteristics
• Ideally, the policy should also be better suited for
the customer’s needs than alternative financial
products and/or arrangements.
The Griffith Insurance Education Foundation
34
Who Decides What’s Suitable?
Two Philosophies
• Let the buyer decide what’s suitable for
him/herself
• Provide full and clear disclosure of all relevant
information related to an annuity
• Put the “burden” on the seller to sell only products
that are suitable for the buyer
• Specify types of information the seller must take into
account
• Require that the insurer review prospective sales for
suitability
The Griffith Insurance Education Foundation
35
Summary of Annuities
• Annuities are financial products that many people
find hard to understand
• Regulators have been concerned that some
people are buying annuities that are unsuitable for
them – particularly variable annuities
• Indexed annuities are still regulated by the states
but have been proposed to be regulated by the
SEC
• Suitability standards are inconsistent from one
jurisdiction to another
• Regulation will differ depending on which
suitability model is relied on
The Griffith Insurance Education Foundation
36
Life Insurance and Annuities
Thank you
For more information contact:
The Griffith Insurance Education Foundation
623 High Street
Worthington, Ohio 43085
Phone: 614-880-9870
Email: [email protected]
The Griffith Insurance Education Foundation
37