Annuity Business Research Articles

Special-Rate Life Annuities: Analysis of Portfolio Risk Profiles

Special-rate life annuities are life annuity products whose single premium is based on a mortality assumption driven (at least to some extent) by the health status of the applicant. The health status is ascertained via an appropriate underwriting step (which explains the alternative expression “underwritten life annuities”). Better annuity rates are then applied in presence of poor health conditions. The worse the health conditions, the smaller the modal age at death (as well as the expected lifetime), but the higher the variance of the lifetime distribution. The latter aspect is due to significant data scarcity as well as to the mix of possible pathologies leading to each specific rating class. A higher degree of (partially unobservable) heterogeneity inside each sub-portfolio of special-rate annuities follows, and this results in a higher variability of the total portfolio payout. The present research aims at analyzing the impact of extending the life annuity portfolio by selling special-rate life annuities. Numerical evaluations have been performed by adopting a deterministic approach as well as a stochastic one, according to diverse assumptions concerning both lifetime distributions and portfolio structure and size. Our achievements witness the possibility of extending the annuity business without taking huge amounts of risk. Hence, the risk management objective “enhancing the company market share” can be pursued without significant worsening of the annuity portfolio risk profile.

The UK equity release market: Views from the regulatory authorities, product providers and advisors

This study investigates the factors constraining the development of the UK equity release market. The results of a thematic review of interviews with industry stakeholders (product providers, advice providers and regulators) suggest that the attractiveness of the equity market for insurance companies (the main funders of the market), has diminished following a decline in annuity business and complications around the capital maturity matching requirements under Solvency II. Product costs (interest charges, and the cost of financial advice) are high. Trust in the market has improved, but remains fragile. Increased entry into the market by recognised brand names, (such as the traditional mortgage providers) would increase competition, reduce costs and promote trust. The risk of reputational damage limits the appeal of the market to new entrants. The no negative equity guarantee, a cost in terms of lower than otherwise loan-to-value ratios, promotes demand by way of the protection it affords to customers and their beneficiaries. Equity release is unsuitable for funding long-term care and policymakers advocating it as such damage the market.

Local religious beliefs and insurance companies' risk-taking behaviour.

We empirically examine the effect of local religious beliefs on the risk-taking behaviour of U.S. life insurers headquartered in that region. We distinguish between insurers that predominantly write annuities and insurers that predominantly write life insurance policies; the annuity business is relatively riskier than writing life insurance. Insurers headquartered in high-Catholic or low-Protestant areas are more likely to be annuity writers. Annuity writers located in high-Catholic or low-Protestant areas invest more in risky assets and exhibit higher investment return volatilities, as well as a higher volatility of their return on assets. Overall, our results suggest that local culture has significant influences on life insurers’ behaviour.Supplementary InformationThe online version contains supplementary material available at 10.1057/s41288-021-00211-z.

Contributory Pension Scheme and the Premium Base of the Nigerian Insurance Industry

The paper investigates the veracity of the hypothetical expectation that the implementation of the Pension Reform Act of 2004, as amended, would lead to a quantum growth in the premium base of the Nigerian insurance industry. Given that prior research had confirmed the power of mandated contributory pension scheme to facilitate growth of the financial sector, the paper argued that the insurance industry, being a subsector of the financial system, would experience its fair share of the expected growth. Employing annual gross premium as a proxy for insurance industry growth and measured over a span of eleven years (2005-2015), regression analysis of data showed that premium income of insurance industry had a positive and no significant relationship with contributory pension scheme (β = 0.8496; t = 1.8282; p = 0.1415 ≥ 0.05). The result not being significant at 5% could be traced to two related factors, namely, the manifest reluctance shown by MDAs and other public sector employers to comply with the provisions of section 9(3) of the Pensions Reform Act, 2004 and the failure of PFAs to expose the early retiring workers to the annuity option of pension payment structure; this hamstrung the growth of the annuity business, a major component of the insurance industry in Nigeria. The paper therefore recommends that pension regulatory authorities in Nigeria should compel strict compliance with the relevant provisions of the Act in order for the insurance industry to experience the expect quantum growth.

The UK Equity Release Market: Views from the Regulatory Authorities, Product Providers and Advisors

This study investigates the factors driving the development of the UK equity release market. The results of a thematic review of semi-structured interviews with industry stakeholders (comprising senior representatives of product providers, advice providers and regulators) suggest that the attractiveness of the equity market for insurance companies (the main funders of the market), has diminished following a decline in annuity business and complications around the capital maturity matching requirements under Solvency II. Product costs (interest charges, and the cost of financial advice) are high. Trust in the market has improved, but remains fragile. Increased entry into the market by recognised brand names, (such as the traditional mortgage providers) would increase competition, reduce costs and promote trust. The risk of reputational damage limits the appeal of the market to new entrants. The no negative equity guarantee, a cost in terms of lower than otherwise loan-to-value ratios, promotes demand by way of the protection it affords to customers and their beneficiaries. Equity release is unsuitable for funding long-term care and policymakers advocating it as such damage the market.

A review of the risk margin – Solvency II and beyond

Abstract For life insurers in the United Kingdom (UK), the risk margin is one of the most controversial aspects of the Solvency II regime which came into force in 2016. The risk margin is the difference between the technical provisions and the best estimate liabilities. The technical provisions are intended to be market-consistent, and so are defined as the amount required to be paid to transfer the business to another undertaking. In practice, the technical provisions cannot be directly calculated, and so the risk margin must be determined using a proxy method; the method chosen for Solvency II is known as the cost-of-capital method. Following the implementation of Solvency II, the risk margin came under considerable criticism for being too large and too sensitive to interest rate movements. These criticisms are particularly valid for annuity business in the UK – such business is of great significance to the system for retirement provision. A further criticism is that mitigation of the impact of the risk margin has led to an increase in reinsurance of longevity risks, particularly to overseas reinsurers. This criticism has led to political interest, and the risk margin was a major element of the Treasury Committee inquiry into EU Insurance Regulation. The working party was set up in response to this criticism. Our brief is to consider both the overall purpose of the risk margin for life insurers and solutions to the current problems, having regard to the possibility of post-Brexit flexibility. We have concluded that a risk margin in some form is necessary, although its size depends on the level of security desired, and so is primarily a political question. We have reviewed possible alternatives to the current risk margin, both within the existing cost-of-capital methodology and considering a wide range of alternatives. We believe that requirements for the risk margin will depend on future circumstances, in particular relating to Brexit, and we have identified a number of possible changes to methodology which should be considered, depending on circumstances.

Hedging Mortality/Longevity Risks for Multiple Years

In this article, we develop strategies of hedging multiyear mortality (longevity) risk for a life insurer (an annuity provider) through purchasing some mortality-linked securities from a financial intermediary. Under the multiyear hedges for a life insurer (an annuity provider) involving two uncertain factors—the mortality rate and the number of life insureds (annuity recipients)—we derive closed-form formulas for the optimal units of purchasing underlying mortality-linked securities. Numerical illustrations show that the downside risk of loss because of mortality (longevity) risk for the life insurer (annuity provider) can be significantly hedged by purchasing the optimal units of mortality-linked securities, and the sample risk can be reduced by increasing the number of life insureds (annuity recipients) at issue. For a financial intermediary, adopting an optimal weight of a portfolio of life and annuity business can reduce extreme losses from the longevity risk but could slightly increase losses from the mortality risk, and the sample risk cannot necessarily be eliminated by increasing the number of life insureds/annuity recipients at issue.

Credibility Methods for Individual Life Insurance

Credibility theory is used widely in group health and casualty insurance. However, it is generally not used in individual life and annuity business. With the introduction of principle-based reserving (PBR), which relies more heavily on company-specific experience, credibility theory is becoming increasingly important for life actuaries. In this paper, we review the two most commonly used credibility methods: limited fluctuation and greatest accuracy (Bühlmann) credibility. We apply the limited fluctuation method to M Financial Group’s experience data and describe some general qualitative observations. In addition, we use simulation to generate a universe of data and compute Limited Fluctuation and greatest accuracy credibility factors for actual-to-expected (A/E) mortality ratios. We also compare the two credibility factors to an intuitive benchmark credibility measure. We see that for our simulated data set, the limited fluctuation factors are significantly lower than the greatest accuracy factors, particularly for low numbers of claims. Thus, the limited fluctuation method may understate the credibility for companies with favorable mortality experience. The greatest accuracy method has a stronger mathematical foundation, but it generally cannot be applied in practice because of data constraints. The National Association of Insurance Commissioners (NAIC) recognizes and is addressing the need for life insurance experience data in support of PBR—this is an area of current work.

LONGEVITY RISK MANAGEMENT AND SHAREHOLDER VALUE FOR A LIFE ANNUITY BUSINESS

AbstractThe life annuity business is heavily exposed to longevity risk. Risk transfer solutions are not yet fully developed, and when available they are expensive. A significant part of the risk must therefore be retained by the life insurer. So far, most of the research work on longevity risk has been mainly concerned with capital requirements and specific risk transfer solutions. However, the impact of longevity risk on shareholder value also deserves attention. While it is commonly accepted that a market-consistent valuation should be performed in this respect, the definition of a fair shareholder value for a life insurance business is not trivial. In this paper, we develop a multi-period market-consistent shareholder value model for a life annuity business. The model allows for systematic and idiosyncratic longevity risk and includes the most significant variables affecting shareholder value: the cost of capital (which in a market-consistent setting must be quantified in terms of frictional and agency costs, net of the value of the limited liability put option), policyholder demand elasticity and the cost of alternative longevity risk management solutions, namely indemnity-based and index-based solutions. We show how the model can be used for assessing the impact of different longevity risk management strategies on life insurer shareholder value and solvency.

Hedging mortality/longevity risks of insurance portfolios for life insurer/annuity provider and financial intermediary

In this paper, we propose two risk hedge schemes in which a life insurer (an annuity provider) can transfer mortality (longevity) risk of a portfolio of life (annuity) exposures to a financial intermediary by paying the hedging premium of a mortality-linked security. The optimal units of the mortality-linked security which maximize hedge effectiveness for a life insurer (an annuity provider) can be derived as closed-form formulas under the risk hedge schemes. Numerical illustrations show that the risk hedge schemes can significantly hedge the downside risk of loss due to mortality (longevity) risk for the life insurer (annuity provider) under some stochastic mortality models. Besides, finding an optimal weight of a portfolio of life and annuity business, the financial intermediary can reduce the sensitivity to mortality rates but the model risk; a security loading may be imposed on the hedge premium for a higher probability of gain to compensate the financial intermediary for the inevitable model risk.

An Analysis of the Relative Risks of the Lifetime Annuity Business and Their Management

An Analysis of the Relative Risks of the Lifetime Annuity Business and Their Management

Managing Life Insurer Risk and Profitability: Annuity Market Development Using Natural Hedging Strategies

Changing demographics creates the potential for the expansion of existing and new products to manage longevity risk. Life annuities address this risk, yet these annuity product markets are thin. Insurers are concerned about the long term risks associated with these longevity products and capital requirements. Life insurers also offer life insurance products, whole-of-life and term, that provide an opportunity to offset longevity risks. This can allow capital efficient longevity risk products to be sold as part of a product portfolio. Natural hedging, or the offsetting of risks in life insurance and annuity business, provides a way of managing capital efficiently as well as improving profitability. This paper uses stochastic mortality and interest rate models to assess life and annuity capital requirements and quantify the benefits of natural hedging taking into account relative profit loadings on products. The benefits of offering longevity products, in terms of capital requirements, as well as the importance of the type of life insurance products offered are illustrated using standard life and annuity products. The impact of capital requirements, such as solvency II with a one-year horizon, are considered and compared to multiple period risk measures to confirm the results hold for regulatory capital requirements.

Modelling dependent data for longevity projections

The risk profile of an insurance company involved in annuity business is heavily affected by the uncertainty in future mortality trends. It is problematic to capture accurately future survival patterns, in particular at retirement ages when the effects of the rectangularization phenomenon and random fluctuations are combined. Another important aspect affecting the projections is related to the so-called cohort-period effect. In particular, the mortality experience of countries in the industrialized world over the course of the twentieth century would suggest a substantial age–time interaction, with the two dominant trends affecting different age groups at different times. From a statistical point of view, this indicates a dependence structure. Also the dependence between ages is an important component in the modeling of mortality (Barrieu et al., 2011). It is observed that the mortality improvements are similar for individuals of contiguous ages (Wills and Sherris, 2008). Moreover, considering the data subdivided by set by single years of age, the correlations between the residuals for adjacent age groups tend to be high (as noted in Denton et al., 2005). This suggests that there is value in exploring the dependence structure, also across time, in other words the inter-period correlation. The aim of this paper is to improve the methodology for forecasting mortality in order to enhance model performance and increase forecasting power by capturing the dependence structure of neighboring observations in the population. To do this, we adapt the methodology for measuring uncertainty in projections in the Lee–Carter context and introduce a tailor-made bootstrap instead of an ordinary bootstrap. The approach is illustrated with an empirical example.

Developments in the Management of Annuity Business ‐ Abstract of the London Discussion – ADDENDUM

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Developments in the Management of Annuity Business

The focus of the paper is non-profit lifetime annuities in the UK. Annuity insurers have been faced with, or have initiated, an unprecedented amount of change during the last decade, and rapid change is still continuing. We draw out implications for the actuarial management of the business, arising from the evolution of: longevity risk assessment and management, investment strategy and operations, financial reporting, and enterprise risk management. We discuss Solvency II in some technical depth, analysing the proposed rules for technical provisions and solvency capital requirement.

Developments in the Management of Annuity Business ‐ Abstract of the London Discussion

Developments in the Management of Annuity Business ‐ Abstract of the London Discussion

Developments in the Management of Annuity Business ‐ Abstract of the Edinburgh Discussion

This abstract relates to the following paper:TelfordP.G., BrowneB.A., CollingeE.J., FulcherP., JohnsonB.E., LittleW., LuJ.L.C., NurseJ.M., SmithD.W. & ZhangF. Developments in the Management of Annuity Business ‐ Abstract of the Edinburgh Discussion. British Actuarial Journal, doi:10.1017/S1357321711000213

Securitization of Longevity Risk Using Percentile Tranching

AbstractSecuritizations that transfer risk to the financial markets are a potential solution to longevity risk in the annuity business. The classical Lee–Carter model is applied to generate the future stochastic survival distribution. A method to design inverse survivor bonds using percentile tranches and to calculate the security prices is presented. The percentile tranche method is a simple and practical way for the issuer to design and price the security. This method can serve to identify the risk–yield relationship, which can provide investors with clear insight regarding the appropriate choice of tranches.

Securitization of Longevity Risks Using Percentile Tranche Methods

As a solution to the longevity risks in annuity business we consider securitizations which transfer the risks to the financial markets. We apply the classical Lee-Carter model to generate the future stochastic survival distribution. We show a method to design the survivor bonds using the percentile tranches and calculate the prices of the securities.

First-Order Mortality Basis for Life Annuities

Mortality improvements pose a challenge for the life annuity business. For the management of such portfolios, it is important to forecast future mortality rates. Standard models for mortality forecasting assume that the force of mortality at age x in calendar year t is of the form exp, where the dynamics of the time index is described by a random walk with drift. Starting from such a best estimate of future mortality (called second-order mortality basis in actuarial science), the paper explains how to determine a conservative life table serving as first-order mortality basis. The idea is to replace the stochastic projected life table with a deterministic conservative one, and to assume mutual independence for the remaining life times. The paper then studies the distribution of the present value of the payments made to a closed group of annuitants. It turns out that De Pril–Panjer algorithm can be used for that purpose under first-order mortality basis. The connection with ruin probabilities is briefly discussed. An inequality between the distribution of the present value of future annuity payments under first-order and second-order mortality basis is provided, which allows to link value-at-risk computed under these two sets of assumptions. A numerical example performed on Belgian mortality statistics illustrates how the approach proposed in this paper can be implemented in practice.