A Little More Interest Needed For SPIAs

One reason why SPIAs have not had better success in the marketplace in the last few years may relate to the interest rate environment. With rates hovering at relatively low levels, buyers may be reluctant to invest large sums of money into a general account SPIA product where the investment is locked up for life at relatively low interest levels. Consumers may be waiting to see if rates are going to rise, as many have predicted, and then, possibly purchase the SPIA.

Delaying the purchase of the SPIA until interest rates rise does make some sense, but when will interest rates rise? And, if rates do go up, what might the expected increase in monthly income be? Few know the answer to the last question, but it seems critical in determining whether the SPIA purchase should be delayed.

Table 1 shows the male and female monthly payout based on four different interest rates. The rates are based on reasonable assumptions: issue age 65, a $100,000 single premium, a 5% premium expense load, mortality based on the Annuity 2000 valuation table, and an annuity for 10 years certain and life. The 5.5% interest rate is representative of the rate used in pricing these annuities in todays interest rate environment.

As illustrated, a 1% increase in interest rates can increase significantly the monthly income from SPIAs. This implies that the reluctance of new retirees to purchase SPIAs immediately may be warranted when interest rates are expected to rise.

In addition to choosing the interest rate(s), a mortality assumption is necessary when determining SPIA monthly income rates. Insurers use different assumptions for mortality improvement in developing the monthly income rates.

The monthly income rates in Table 1 did not assume any mortality improvement, a common assumption. This is addressed in Table 2.

Table 2 shows the effect of a mortality improvement assumption, using the same assumptions as Table 1, including a 5.5% interest rate. Mortality improvement is assumed based on “Scale G,” an improvement scale often used to project annuity mortality improvement.

As indicated, the change in monthly income rates based on the mortality improvement assumption is not nearly as critical as a change in the interest rate assumption.

If the perception is that interest rates will increase in the near future, consumers may hold back on SPIA purchases because they realize that the expected increase in rates may bring significantly more monthly income.

Therefore, it may not be until either the perception that interest rates will increase or that interest rates actually do increase that sales of SPIAs take off.

Kent C. Scheiwe, FSA, MAAA, is a principal in the Indianapolis office of the Milliman actuarial consulting firm. His e-mail address is [email protected].

Reproduced from National Underwriter Edition, February 25, 2005. Copyright 2005 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.