Annuities: a private solution to longevity risk Product & Knowledge Fair 2007 Rüschlikon 30 March 2007 Thomas Hess Head of Economic Research & Consulting Veronica Scotti Client Solutions
Need for private solution is growing Life expectancy at birth in different regions Old-age dependency ratio* in selected countries 100 % 80 % 90 60 80 70 40 60 20 50 40 1950-1955 1960-1965 1970-1975 1980-1985 1990-1995 2000-2005 2010-2015 Germany World USA Japan France UK 2020-2025 2030-2035 2040-2045 0 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 Germany World USA Italy Japan France UK Slide 2 Source: United Nations, World Population Prospects, 2004 Revision *Ratio of the population aged 65+ to the population aged 15-64
The role of the insurance sector In the accumulation phase In the decumulation phase By helping individuals build up a desirle level of savings throughout their working years: By allowing individuals to run their asset pool down smoothly while offering protection against longevity and inflation: in a flexible way (in the amount and timing of their contributions to the capitalisation plan) in an efficient way (via investment diversification, gradual adjustment of the risk/return profile based on age, tax advantages) through various types of annuities through health care and longterm care insurance through wealth monetisation (eg reverse mortgage) Slide 3 through wealth transfer in the case of early death
Size of annuity markets Switzerland Total assets 75'896 Annuity assets 15'567 % 21% Netherlands 50'014 8 107 16% United States 45'876 6 912 15% United Kingdom 41'336 21 141 51% Australia 29'229 3 896 13% Japan 17'596 250 1% Germany 10'646 1 507 14% Italy 6'392 83 1% 0 20'000 40'000 60'000 80'000 (USD per capita, 2004 data) Assets for Pension Funds Assets for Life Insurers of which: backing annuities Slide 4 Source: OECD Global Pension Statistics; OECD Insurance Statistic Yearbook; insurance associationsof represented countries
Total pension expenditure in % of GDP 14% 12% 10% 8% 6% 4% 2% 0% Public Ireland Private New Zealand Australia Canada Spain Netherlands USA UK Germany France Slide 5 Source: Report of the Pensions (Turner Commission), 2005; OECD, 2004, Social Expenditure Datase (1980-2001) Note: Data was not availle for Ireland, New Zealand and Spain
Slide 6 Role of pension system: Pension funds and life insurance assets penetration % of GDP 1998 1999 2005 2005 2006 2000 1956/1985 1964/1985 1992 1985 1986 160% 140% 120% 100% 80% 56.5% 60% Voluntary 40% 20% Mandatory (year of introduction) 0% Greece Switzerland Iceland Netherlands United United States Denmark Australia Ireland Canada Sweden Finland France Japan Belgium Norway Germany Austria Italy Portugal Slovakia Spain Korea New Zealand Hungary Poland Czech Turkey
Main risks and costs affecting annuity profitility Insurance risks - Longevity risk - Persistency risk Financial-market risks - Interest-rate risk/ - Investment risk - Unhedged inflation risk Costs - Administration costs -Distribution costs - Capital costs Underwriting activity Investment activity Operating activity insured s buying behavior risk management prowess scope for diversification hedging instruments use product structure Slide 7
Longevity risk: Rectangularisation of the mortality curve Probility of surviving from one year to the other 100% 80% 60% 40% 20% 0% 0 7 14 21 28 35 42 49 56 63 70 77 84 91 98 Age 1980-1982 GAD UK male tle 2002-2004 GAD UK male tle Slide 8 Source: UK GAD
Longevity risk: Uncertainty in demographic projections Share of population > 65 years (%) North America Latin America Africa projected actuall Southern Europe Western Europe South-East Asia China Japan Slide 9 Projection 1963 Actual 2000 World 0 5 10 15 20 Source: IMF, World Economic Outlook (2004)
Longevity risk: Projections errors grow with time span Absolute projection error (mean values) 0.20% 0.15% 0.10% 0.05% 0.00% 5 10 15 20 25 30 Projection length (years) Slide 10 Source: IMF, World Economic Outlook (2004)
Interest rate risk: Guaranteed rates vs. market yields % 16 14 12 10 8 6 4 2 0 Jan 90 Jan 92 Jan 94 Jan 96 Jan 98 Jan 00 Jan 02 Jan 04 Jan 06 8000 7000 6000 5000 4000 3000 2000 1000 0 LT Govt bond yield Guaranteed Rate DAX (rhs) Slide 11
Managing longevity risk: The role of different players Insured longevity risk Diversification State Insurers Diversification Pricing/ product design Education / distribution Risk sorption Reinsurers Risk sorption U/w support Capital management Slide 12 Capital Markets Risk transfer Hedging instruments