Annuities can provide security in retirement

 In the life insurance business, annuity is a name of an insurance product that provides a future stream of income for life or a set period. Compared with usual life insurance products which provide protection against financial loss in the event of dying too early (so-called "premature death risk"), an annuity provides security of income in the event of living too long (so-called "longevity risk").

For example, Somchai plans to retire at age 60 and expects to require Bt300,000 per annum to live comfortably. If he estimates that he may live 20 years after retirement, it means that he needs to keep aside a fund of Bt6 million (300,000 x 20) to provide post-retirement income. If he is 30 years old, he would need to save around Bt130,000 a year to get a total fund of Bt6 million when he turns 60, assuming a 3 per cent return on his investment.

This savings regime looks simple and does not require any insurance backup. But the question is, what happens if Somchai lives beyond age 80. At that time, he has already used up all his Bt6 million savings. You may argue that this issue can be solved by being conservative about survival assumptions. For instance, let's assume that Somchai could live to age 100. In this case, he would have to save Bt260,000 a year (double the earlier plan) even though he doubts he will live to 100.

A practical solution to deal with the uncertainty is to purchase an annuity from a life assurance company. For example, Somchai gives his Bt6 million savings pot to an insurance company in exchange for an annuity contract that guarantees to provide an annual income as long as he lives. But the actual savings amount will depend on a statistical calculation, which is not necessarily going to be equal to the Bt130,000 required in the previous option. In this case, Somchai only needs to pay whatever the required annuity premium is, while the uncertainty about lifespan is transferred to the insurance company.

Generally, an annuity contract period can be separated into two phases. The first is called the accumulation phase. Under this, the money received from customers (called premiums or considerations) is invested and the returns are accumulated. Depending on investment structure, the returns can be in the form of interest credits or varied with stock unit performance. After the accumulation phase, the second phase is the period when the accumulated money is paid out.

Depending on the type of plan, some annuity contracts provide various options to receive payment. The basic option mentioned in the above example is a "life annuity" when regular annuity payments end upon the customer's death.

However, the major disadvantage of a life annuity option is the amount of total payment received can be very small (compared to the premiums paid) if early death occurs. So some options modify life annuities by providing minimum guarantees either in the number of payments or payment amount. More complex options provide regular payments depending on survival of more than one life (ie husband and wife), this is known as a last survivor annuity.

American International Assurance (AIA) has launched several annuity products around the world that is benefiting customers. Thailand's insurance market doesn't have any real annuity products available yet but the company hopes to see this changed in the near future.

Suchin Pongpuengpitack is AIA's assistant vice president - actuarial.