By Kent C. Scheiwe
The premium dollars flowing into single premium immediate annuities in 2002 reached over $5 billion, but this represents only about 2.5% of the premiums that went into their deferred counterpart, single premium deferred annuities.
Can the industry expect this percentage to increase? How might SPIAs change in the next few years? This article examines both questions.
Traditionally, SPIAs have been an unattractive product for insurance representatives and companies to sell.
For reps, the drawback is that SPIA commissions are generally less than SPDA commissions, and SPIAs lock up the clients funds for life with little, if any, liquidity.
For insurers, lack of profitability is a key problem with the SPIA. Two primary reasons account for this. First, insurers have been required to set up SPIA reserves that are often much greater than initial premium received. For example, a company may have to set up a reserve in excess of $110,000 for a $100,000 SPIA. This results in surplus strain to the company and a drag on profitability of the SPIA.
The second reason is that mortality improvement has hampered profitability. With improvements in medical care, annuitants are living longer. This has resulted in additional SPIA payments to annuitants, thus curbing profits.
In the next few years, however, two environmental changes will help make SPIAs more popular. One is the large balances that people hold in defined contribution pension plans and IRAs. At retirement, many of these individuals may want to invest a portion of their accumulated funds in SPIAs in order to receive a guaranteed monthly income for life.
The other change is the aging of the baby boom population. The closer boomers come to retirement, the greater will be their concern about outliving their investments. Again, SPIAs answer this concern by providing a guaranteed monthly income for life.
In view of these coming changes, insurers may want to consider changing the overall commissions they pay on SPIAs. By increasing first-year commissions or adding trailer commissions, for example, insurers might help SPIAs become more attractive to insurance representatives.
Regarding the strain on surplus, this should be less of a problem. As a result of the current low interest rate environment, insurers are experiencing little, if any, surplus strain when issuing SPIAs. This should make SPIAs more attractive for insurers to sell.
Concerning mortality improvement, a few companies are beginning to underwrite SPIAs, placing annuitants into risk classifications much as is done with life insurance. Proper classification may provide a more equitable payout for annuitants.
As more companies begin underwriting SPIAs, the remaining companies will be forced to do so also–or face anti-selection from customers who gravitate to the best SPIA rates.
The best rates for those in poor health generally will be offered by insurers that underwrite. The best rates for those in good health generally will be offered by insurers that do not underwrite but expect a mix of healthy and unhealthy annuitants. (If these companies receive mostly healthy annuitants, the profitability on their SPIA business will deteriorate.)
Insurers may be reluctant to underwrite SPIAs because little mortality data are available to classify annuitants into risk classes. Until this data becomes available, actuaries will have to price these SPIAs based on judgment concerning expected mortality rates.
Underwriting SPIAs will change the sales process. For example, the travel time from completing the application to policy delivery will be extended due to the added underwriting time. Also, insurers may add incontestability clauses to their SPIA contracts, forcing representatives to explain additional contract provisions to annuitants upon policy delivery.
Also, when purchasing life insurance, applicants typically present themselves in the healthiest light. But when purchasing SPIAs, they will have the incentive to present themselves in the unhealthiest light in order to be placed in the risk class making the highest monthly payout.
Table 1 illustrates why this is so by showing the monthly income for a $100,000 SPIA that is payable for life for a male and a female, issue age 65. Values in the table are based on a 5.5% earned rate and the Annuity 2000 Basic Table, a mortality table often used in determining SPIA income values. Mortality is assumed to improve at 1% a year for males and 0.5% a year for females. A standard annuitant is based on 100% of the mortality table.
The Table shows that underwriting SPIAs may result in much different monthly income values for annuitants of the same issue age. For example, the Table shows that insurers that currently do not underwrite their SPIAs may offer a monthly income value of $713.06 for males and $667.69 for females in the test scenario. If, however, the annuitant has medical impairments resulting in twice the standard expected mortality (200% of standard), the monthly income values increase to $873.08 for males and $781.85 for females.
This is a monthly income increase of 22.4% for males and 17.1% for females.
If we assume that payments are paid for the life of the annuitant, but not less than 10 years, the values change as shown in the Table II. Consumers often choose this type of SPIA, preferring the guarantee that they or their beneficiaries will receive payments for 10 years. The Table shows that the addition of the period certain to the monthly payments lessens the effect of underwriting.
Therefore, in the future, expect SPIA sales to increase. Also expect SPIA companies to change the way they compensate agents for SPIA sales, and to change the way they underwrite SPIA applicants. While little, if any, underwriting is currently performed, future SPIAs may have much more extensive underwriting.
Kent C. Scheiwe, FSA, MAAA, is a principal in the Indianapolis office of the Milliman USA actuarial consulting firm. His e-mail is email@example.com.
Reproduced from National Underwriter Edition, July 7, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.