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Introduction
Immediate annuities are generally used as an income stream for retirees. An individual would pay the insurer a one-off premium or a series of regular premium to accumulate wealth, which would be annuitised and be paid back to the individual during the retirement life. The main purpose of this product is to hedge longevity risk, preventing the insured from outliving their available assets. As retirees look for a stable income replacement after retirement, they may seek annuities providing high guaranteed income with or without potential non-guaranteed income.
Note that buying an annuity is exchanging liquid assets into stable future income, surrendering it for urgent use may incur a significant loss. The insured may also suffer financial losses if the unfortunate event of death occurs early during the policy. 10Life calculates the score for each immediate annuity product by its longevity risk coverage, guaranteed return, projected return, early surrender coverage and early death coverage.
Assumptions: for Pre-retirement Age
There is a large variety of annuity products, with different premium payment periods, income periods and currency options. Immediate annuities usually require a large premium being paid during a short period of time just before retirement. Individuals planning to retire from in the near or immediate future may consider these products. We assume that the insured is a male at closest to age 65, planning to receive annuity income at age 65.
Guaranteed Return Score
Insurers are obligated to pay the guaranteed income as a living benefit to the policyholder. 10Life calculates the guaranteed cash flow by considering the premium paid and guaranteed income in the scenario that the policyholder is alive at the age of 105.
10Life calculates the present value (PV) of income received versus premium paid discounted by the risk-free rates assuming the policy commences today. Risk-free rates of different currencies are determined by the long-term yields of the respective government bonds.
- USD: United States Treasury Bonds
- HKD: Hong Kong Exchange Fund Notes
The risk-free rates may be updated from time to time to reflect changes in the market.
The Guaranteed Return Score is calculated by the ratio of PV of income received and PV of premium paid, compared against the benchmark.
| Ratio = | PV(Guaranteed income received at age 105) | , using risk free rate as discount factor |
| PV(Premium paid) |
Projected Return Score
Some products offer a non-guaranteed income for the policyholder in the policy projection, which is subject to change by the insurer. 10Life calculates the projected cash flow by considering the premium paid and projected income in the scenario that the policyholder is alive at the age of 105.
10Life calculates the present value (PV) of income received versus premium paid discounted by the market rates assuming the policy commences today. Risk-free rates of different currencies are determined by the long-term yields of the respective government bonds.
- USD: United States Treasury Bonds
- HKD: Hong Kong Exchange Fund Notes
We then use the Capital Asset Pricing Model (CAPM) to derive market rates of the respective currency. The risk-free rates and market risk assumptions may be updated from time to time to reflect changes in the market.
The Guaranteed Return Score is calculated by the ratio of PV of income received and PV of premium paid, compared against the benchmark.
| Ratio = | PV(Projected income received at age 105) | , using market rate as discount factor |
| PV(Premium paid) |
Since the implementation of GL16 in early 2017, insurers are required to disclose fulfillment ratios of non-guaranteed dividends or bonuses. However, current published data available in the market mainly cover the fulfillment ratios of the first few policy years, making it insufficient to determine the ability of insurers fulfilling these long-term non-guaranteed returns. Moreover, products and market assumptions are constantly changing, making it difficult to predict future returns based on past returns. Therefore, 10Life does not take published fulfillment ratios into the calculations of the Projected Return Score.
Longevity Coverage Score
Retirees face the risk of their assets being exhausted during their lifetime, which is more likely to happen if the individual lives longer than expected. Hence, annuity coverage is particularly important at later ages.
Based on the coverage term, 10Life scores longevity coverage based on the following scale.
Coverage until |
10Life Score |
Lifetime | 10 |
Age 100 | 9
|
Age 85 | 6
|
Below age 85 | 0
|
Early Surrender Coverage Score
While the intended use of annuity insurance is not for early cash out, there may be cases where an urgent unexpected use of cash is required after purchasing the product. 10Life calculates the Early Surrender Coverage Score based on the guaranteed benefit per premium paid in the following scenarios:
- Surrender at the 10th policy year
- Surrender at the 20th policy year
Guaranteed benefit per premium paid is calculated by the following formula.
Guaranteed benefit per premium paid = |
Guaranteed income received (if any) + Guaranteed cash value | |
| Total premium paid |
The Early Surrender Coverage Score is based on the average of these 2 scenarios.
Early Death Coverage Score
The main purpose of immediate annuity products is to mitigate longevity risk. However, in the unfortunate event that the insured dies during the early policy years before breaking even, most annuity products offer a death benefit either as a lump sum payout or a guaranteed continued annuity payout to the beneficiary. 10Life calculates the Early Death Coverage Score based on the guaranteed benefit per premium paid in the following scenarios:
- Death at the 10st policy year
- Death at the 20th policy year
Guaranteed benefit per premium paid is calculated by the following formula:
Guaranteed benefit per premium paid = |
Guaranteed income received (if any) + Guaranteed death benefit | |
| Total premium paid |
The Early Death Coverage Score is based on the average of the 2 scenarios.
Overall Score
As the main purpose of immediate annuities is to cover longevity risk while providing stable income after retirement, 10Life puts the most emphasis on guaranteed return in scoring immediate annuity products, the score weighting is presented in the following table.
Overall Score
| 100%
|
Guaranteed Return Score
| 60%
|
Projected Return Score
| 10%
|
Longevity Coverage Score
| 15%
|
Early Surrender Coverage Score
| 10%
|
Early Death Coverage Score
| 5%
|
10Life strives to offer an unbiased scoring methodology to compare insurance products through data analyses and mathematical calculations, based on public information from insurers. 10Life scores are for reference only, and do not constitute any insurance sales advice. As everyone has different insurance needs and affordability levels, you should seek independent advice from licensed insurance advisors before purchasing any insurance products. 10Life may review the scoring methodology from time to time to improve the product comparisons. If you have any questions or suggestions on the methodology, please email us at enquiries@10Life.com.
Updated on 27 April 2021
