Different Types of
Annuities
P. Antolín
OECD, Private Pension Unit at
DAF/FIN
1
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).
2
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).
3
Annuity payments and products
• A public pension is a stream of income
paid at regular intervals.
• The pension benefits paid by a definedbenefit pension plan is a stream of income
paid at regular intervals.
• An annuity product is a contract, different
from an annuity payment.
4
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.
5
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 one’s resources).
6
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.
7
Type of annuity products
• There are several dimensions to classified
annuity products.
• According to the type of guarantees they
provide.
8
According to how they financed
• Single premium
• Flexible premium (e.g. contributions)
– Fixed
– Variable
9
According to primary purpose
• Immediate pay-out
• Deferred (accumulation)
10
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
14
Several dimensions to classify annuities
How they are financed
• Single premium
• Flexible premium (contributions)
• Fixed
• Variable
Nature of the pay-out
commitment
•
•
•
•
Fixed-term or annuity certain
Life annuity
Temporary annuity
Guarantee annuity
Primary purpose
• Immediate pay-out
• Deferred (accumulation)
• Fixed
• Variable
• Equity-indexed
People covered
Providers
(accumulation or payout phase)
• Qualified
• Non-qualified
Way the annuity is
purchased
• Individual
• Group
Underlying investment
• Single
• Joint-and-survivor
Others
• Tax advantages
• Enhanced vs impaired annuities
• Inflation indexed 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
1. Impact of LR on the total amount of
annuity payments (liabilities)
(LR: uncertainty regarding future mortality
and life expectancy outcomes)
2. 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.
A fund (membership structure 2.5, 10,
• Case 1: using projections of
improvements in life expectancy 25 and 62.5%)
at birth of only 1.2 years per
decade.
• Case 2: life expectancy at birth
increases a 2.2 years per decade.
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
Improvements in life expectancy
3.5
4.5
5.5
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
individual aged 65 in 2005
122.3
111.6
102.4
individual aged 25 in 2005
312.7
192.6
119.8
Source: OECD
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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THANK YOU!
pablo.antolin@oecd.org
http://www.oecd.org/daf/pensions