Different Types of Annuities

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Different Types of Annuities

• P. Antolín
• OECD, Private Pension Unit at DAF/FIN

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Structure of the talk

• What do we mean by annuities?
• Distinguishing between annuity payments and
  annuity products.
• The type of annuity products.
• How annuity products can help bridge the
  transition from accumulation to payout phase.
• The risks involved (e.g. longevity risk).

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What is an annuity?

• An annuity is an amount of money paid to someone
  at some regular interval.
• Most people think in terms of annuity products
  an agreement or contract for one person or
  organisation to pay another (the annuitant) a
  stream or series of payments (annuity payments).

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Annuity payments and products

• A public pension is a stream of income paid at
  regular intervals.
• The pension benefits paid by a defined-benefit
  pension plan is a stream of income paid at
  regular intervals.
• An annuity product is a contract, different from
  an annuity payment.

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Annuitization

• Financial economics people better off if a large
  share of their retirement income is annuitized
  (protect against longevity risk)
• Until recently people where heavily annuitized
  through public pensions and DB pension plans.
• They both provide a constant stream of income at
  retirement or annuity payment.

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Relevance of annuity products

• Recent changes in public pensions lower RR.
• Shift from DB to DC funded pension plans
• Need to buy annuity products to protect against
  risks, especially longevity risk (the likelihood
  of outliving ones resources).

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Relevance of annuity products

• Some countries in LA and CEE have introduced DC
  personal plans as main source of retirement
  income.
• At retirement, pension wealth is the form of a
  lump-sum. Retirement income is not annuitized.
• Annuity products could help in bridging the
  accumulation and the pay-out phase.

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Type of annuity products

• There are several dimensions to classified
  annuity products.
• According to the type of guarantees they provide.

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According to how they financed

• Single premium
• Flexible premium (e.g. contributions)
• Fixed
• Variable

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According to primary purpose

• Immediate pay-out
• Deferred (accumulation)

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According to the underlying investment

• According how annuity products create future
  value
• Fixed guarantee a return and a specific payout
  at retirement.
• Variable returns and payment depend on how your
  portfolio performs
• Equity-index

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According to the nature of the payout commitment

• The duration of the payout
• Life payout last for the life time of the
  annuitant
• Fixed-tem or certain e.g. 10 years
• Temporary payout last for the earlier of the two
• Guarantee payout last for the later of the two

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According to the providers

• Qualified annuities the provider during both the
  accumulation and the pay-out phases is the same
  (annuities as vehicles attached to certain
  retirement plans, 401(k)s, IRAs)
• Non-qualified providers are separate entities

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According to

• People covered
• Single
• Joint-survivor
• Way annuity is purchased
• Individual
• Group
• Other feature
• Enhanced or impaired
• Inflation indexed
• Tax advantages

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Several dimensions to classify annuities
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Annuity products and guarantees

• What distinguishes the different type of annuity
  products is the type of guarantees they provide
• These guarantees determine the size of the risks
  involved in annuities
• Longevity risk.
• Investment risk.
• Interest rate risk.
• Inflation risk.

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Annuity products and risks

• Life, deferred and fixed annuity. This is the
  annuity product that replicates a DB plan
• Impact of LR on the total amount of annuity
  payments (liabilities)
• (LR uncertainty regarding future mortality and
  life expectancy outcomes)
• The interaction btw the risks involved (interest
  rate and LR) super-additivity.

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The impact of unexpected gains in LEx

• Increase in the NPV of annuity payments to an
  individual aged 70, 65, 55 and 35 in 2005.
• The payment is 10.000 in 2005. Wages grow at
  1.75, inflation 1.75 and the discount rate is
  3.5
• Base case using current life tables.
• Case 1 using projections of improvements in life
  expectancy at birth of only 1.2 years per decade.
  
• Case 2 life expectancy at birth increases a 2.2
  years per decade.

A fund (membership structure 2.5, 10, 25 and
62.5)
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Impact of longevity improvements and changes in
interest rates on annuity payments Percentage
change in the net present value of annuity
payments, 2005- 2090
Interest rates Interest rates Interest rates
Improvements in life expectancy 3.5 4.5 5.5
No improvements, latest available mortality table used (2005) No improvements, latest available mortality table used (2005) No improvements, latest available mortality table used (2005)
individual aged 65 in 2005 118.6 108.6 100.0
individual aged 25 in 2005 254.6 158.9 100.0
Life expectancy improves by 1.2 years per decade Life expectancy improves by 1.2 years per decade Life expectancy improves by 1.2 years per decade
individual aged 65 in 2005 122.3 111.6 102.4
individual aged 25 in 2005 312.7 192.6 119.8
Source OECD
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Conclusions

• Annuity products could help bridge the transition
  from the accumulation to the payout phase.
• Several types of annuity products depending on
  the type of guarantees provided.
• Depending on those guarantees different impact of
  risks.
• LR non-negligible. Super-additivity effect.

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