Many have forecasted that single premium immediate annuities (SPIAs) will become immensely popular as baby boomers enter their retirement years and start looking for fixed income security.
This article looks at why the SPIA market may be on the cusp of blossoming. It also examines factors that may be holding the market back, especially the current low interest rate environment.
Much has been written concerning the expected growing popularity of the SPIA product. With fewer and fewer defined benefit pension plans, most retirement money has been placed in accumulation-type vehicles such as 401(k) plans.
Upon retirement, the retiree will have many choices to make with the invested assets. One of those choices may be to purchase an SPIA that guarantees a monthly income for the life of the annuitant. The SPIA can serve as the foundation of the post-retirement investment plan, providing guaranteed income for the life of the annuitant regardless of how the other retirement assets may perform.
The market seems ready to pounce on this opportunity. Unfortunately, the insurance industry may not be ready to offer products the market will demand. Many reasons have been documented as to why SPIAs may not have “caught on” as many expected:
Current products lack flexibility for the annuitant. Life situations change, but the typical SPIA offers few options to allow the annuitant to adapt to change.
Sales compensation historically has been low. In addition to this, once the sales representative makes this sale, there is no hope of receiving another commission on these funds at some time in the future.
Some insurers are reluctant to invest heavily in the SPIA market because the profitability of this product in many companies historically has been marginal at best. The increased longevity of the U.S. population has increased the expected number of annuity payments, robbing the product of expected profits in the later years.
The good news is that solutions are in the hands of the industry through creatively addressing these issues and designing products that meet the needs of annuitants, sales representatives and carriers.
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@example.com.
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.