Laughable annuity quotes

PipPip

The insurance company is forced by regulation to hold capital to cover the risk that people will live longer. A high degree if prudence is required by the regulator so this ties up a lot of capital. If my memory is correct the regulations changed such that insurers also have to assume that they can only earn risk free gilt rates on the money for the entire life of the annuitants when they calculate the capital they have to hold, I.e. they have to calculate the future liabilities using a very low risk free rate of return which artificially inflates the capital they have to hold. This capital could be invested in more profitable less risky business hence they have a large "opportunity cost" when writing annuities and this is why so few companies offer them now. Unless you understand these complex bases on which insurance companies are regulated from a capital perspective quite frankly you have no idea how profitable or otherwise (and it is "otherwise") it is for insurers to write annuity business. Using individual cases and fag packet estimates of investment returns you think you could get with the money is pretty worthless as you are not providing anyone with a guarantee, taking on longevity risk for others or having to comply with prudent regulatory capital requirements.

Proxy

PipPip wrote: »

If my memory is correct the regulations changed such that insurers also have to assume that they can only earn risk free gilt rates on the money for the entire life of the annuitants when they calculate the capital they have to hold, I.e. they have to calculate the future liabilities using a very low risk free rate of return which artificially inflates the capital they have to hold.

It isn't true. Most competitive providers current invest in a range of corporate bonds, commercial mortgages and equity release - and barely anything in gilts. If annuities were invested in gilts the returns would be much lower than a gilt, as there's all the associated costs plus longevity risks that have to paid for.

Solvency II tightens the rules somewhat but still allows for the use of assets, and not forgetting solvency II hasn't landed yet and may never...

Otherwise you're pretty spot on.

PipPip

Proxy wrote: »

It isn't true. Most competitive providers current invest in a range of corporate bonds, commercial mortgages and equity release - and barely anything in gilts. If annuities were invested in gilts the returns would be much lower than a gilt, as there's all the associated costs plus longevity risks that have to paid for.

Solvency II tightens the rules somewhat but still allows for the use of assets, and not forgetting solvency II hasn't landed yet and may never...

Otherwise you're pretty spot on.

Thanks. My memory of this is a bit hazy as it was a few years ago and its not my normal job. I recall that a variety of assets could be invested in by the insurer but actual annuity liabilties had to be discounted at risk free rates with no credit allowed for illiquidity premiums inherent in the corporate bonds held on the asset side, which was the point I was trying make. I do recall this was solvency II driving this and that there were too many actuaries making my head hurt! Fundamentally though it seemed like a capital heavy and very risky business to offer annuities, even if buyers see them as a rip off!

Aegis

Linton wrote: »

Yes - but the total number of people with DoB 4/4/1948 that comprise the average include those who have already died. These dead people wont be buying annuities. The average life expectancy of those people who buy annuities will be therefore higher than the average of all those born on 4/4/1948.

There is another factor - people who buy annuities will tend to be richer than average and the richer people are the bigger annuity they will buy. Rich people tend to live longer than poor people. So the annuity biased average life expectancy experienced by insurance companies would be expected to be higher than the national average across the whole population.

Plus the people with the shortest life expectancies tend to either go for scheme pensions, full commutation, enhanced annuities or deferred retirement, so a lot of the shortest life expectancies are removed from the standard annuity market.

Proxy

PipPip wrote: »

Thanks. My memory of this is a bit hazy as it was a few years ago and its not my normal job. I recall that a variety of assets could be invested in by the insurer but actual annuity liabilties had to be discounted at risk free rates with no credit allowed for illiquidity premiums inherent in the corporate bonds held on the asset side, which was the point I was trying make. I do recall this was solvency II driving this and that there were too many actuaries making my head hurt! Fundamentally though it seemed like a capital heavy and very risky business to offer annuities, even if buyers see them as a rip off!

It's *somewhat* true in that context. It's a tricky game.

Old_Slaphead

Aegis wrote: »

Plus the people with the shortest life expectancies tend to either go for scheme pensions, full commutation, enhanced annuities or deferred retirement, so a lot of the shortest life expectancies are removed from the standard annuity market.

Conversly it could be argued that the rich, ie those with longer life expectancies, are less likely to go the annuity route as they have more cost effective options available and are more likely to take more of an active interest in investments. Also, those with low pension funds, ie the poor, are more likely to take a default annuity option as they are less well informed and alternatives like drawdown will be relatively expensive.

The reality is no-one actually knows how profitable annuity provision is but to the layman it looks like a pretty poor deal - most of the blame for which can be laid at the feet of the government and financial service industry who see pension provision as a giant piggy bank to be raided at will.

jamesd

Old_Slaphead wrote: »

I checked several calculators and used an average based on a man with DOB 4/4/1948.

Calculators are likely to use wrong or outdated projections. Notably to use life expectancy at birth or maybe period life expectancy instead of cohort life expectancy. The latter mistake is common enough that ONS has a page that tells people which one they should be using.

Old_Slaphead wrote: »

I surmise that the mid 80s life expectancy anticipated increases in longevity over the next 2 decades through medical innovation.

The one to use for retirement planning is the 2008 ONS cohort life expectancy table for the principal life expectancy projection (2010 is pending). That says how long a person of a particular age is expected to live today and as they live through all future years until they reach their projected end of life expectancy date. Best to look for the projection for the age at which you plan to retire, not current age, because you don't care about retirement if you've died before retiring.

For contingency planning the long life expectancy variant can be used. there's also a short life expectancy one. For a 65 year old in 2013 the projections are:

Principal: 21.7 more years male, 24.2 female (so 86.7 and 89.4 total)
High: 23.1 male, 25.4 female
Low: 20.5 male, 23.2 female

The 2010 data values are likely to be higher than these.

Contingency planning shouldn't stop with these because this is half will live this long or longer and you really don't want a 50% chance of running out of money before you die.

Just_landed

Linton wrote: »

Fixed Rate Annuity for £100K for someone aged 65: £5750/yr from Canada Life. This doesnt look like "well under 5K" to me.

Its approx 17 years "coverage". Average life expectancy for someone aged 65 now is about 87 so 50% of people are expected to live longer. About 10% are expected to reach 100. So not such a bad deal considering current interest rates.

Where's the interest over those 17 years ?

Linton

Just_landed wrote: »

Where's the interest over those 17 years ?

If you look back over the thread you will see the OP defined "the coverage" to be the point at which the total paid out is equal to the initial value of the pot - ie a zero interest rate.

However as you will see from the calculations putting in a realistic current "safe" interest rate of say 3-4% after charges results in the break even point being not very vastly different to the average life expectancy. Thus one concludes that the insurance companies are not making massive profits from annuities especially considering the risk they are taking with possible extensions to life expectancy over the next quarter century or so.