Life Insurance and Annuities R. B. Drennan, PhD Temple University August 20, 2011

1. Life Insurance and AnnuitiesR. B. Drennan, PhDTemple UniversityAugust 20, 2011 INFORM+INSPIRE The Griffith Insurance Education Foundation

2. Life Numbers… • How long will you live? • What is “life expectancy”? • Males/Females • Today: M / F The Griffith Insurance Education Foundation

3. 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

4. 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

5. mortality curve (~term) Term Life Insurance Pricing $ or p(l) x time 100 The Griffith Insurance Education Foundation

6. mortality curve (~term) level premium Term Versus Permanent Pricing $ or p(l) under payment overpayment x time 100 The Griffith Insurance Education Foundation

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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

13. 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

14. Annuities • Oscar Wilde: • “…It is better to have a permanent income than to be fascinating.” The Griffith Insurance Education Foundation

15. 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

16. How Long Will Retirement Assets Last? The Griffith Insurance Education Foundation

17. 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

18. 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, 65-year-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

19. 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

20. 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

21. 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

22. 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

23. 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 • Highest periodic income • But potential for big forfeiture • Life annuity w/ guaranteed payments • 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

24. Deferred Annuities,Classified by Underlying Investment The Griffith Insurance Education Foundation

25. 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

26. 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

27. 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

28. 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

29. Individual Annuity Sales – 2001-2010 The Griffith Insurance Education Foundation

30. Annuity Regulation Currently, Who Regulates What? The Griffith Insurance Education Foundation

31. 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

32. 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

33. 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

34. “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

35. 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

36. 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

37. 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: info@griffithfoundation.org The Griffith Insurance Education Foundation