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Mortality rates – a profit of doom?

I was delighted to see my name liberally sprinkled throughout Mike Fuller&#39s piece on with-profits annuities (Money Marketing, Decem ber 7). Until, that is, I realised that, far from agreeing with my positive views about with-profits annuities, Mike is a “pro phet of doom” as far as this popular product is concerned.

Clearly, Mike is out of step with the army of providers which has launched with-profits annuity products over the past 18 months.

Contrary to Mike&#39s assertion, I do not claim to be an “expert” on annuities but I am a member of a team who specialise in annuities and who have led the successful promotion of with-profits annuities in the IFA marketplace since 1991.

This team in cludes Rich ard Willets whose expertise in the field of mortality risk analysis is widely recognised in the industry and actuarial profession. Indeed, his ground-breaking paper entitled Mortality in the Next Millennium has greatly advanced understanding of this complex area.

Mortality is a fascinating subject. It is certainly not just a question of “we are all living longer”. For example, the recent improvements in long evity have been helped by the healthy, if spartan, diets enjoyed by those brought up in the 1930s and 40s.

A “cohort effect” has cau sed a wave of rapid improvements to ripple upwards through mort ality rates in the UK.

For the past four dec ades, people born between 1925 and 1945 have benefited from faster mortality improvements than those born in adjacent generations.

The greatest mortality im provements in the 1960s were experienced by people then in their 30s, in the 1970s it was people then in their 40s, in the 1980s it was people then in their 50s and now in the 1990s it is people in their 60s. This illustrates the cohort effect centred on 1931. Whether the fast-food generations that followed can sustain the trend remains to be seen.

Where you live can also be an indicator of your life expectancy. This is a fact not lost on MGM which offers higher annuity rates to customers in the North of England and Scotland. Com ing from Sun derland, as I do, I find this fact slig htly disturbing. Like most people, given the choice between the possibility of slightly higher pension increases in the future or a longer life, I would choose the latter – especially now that Sunderland are in the Prem iership.

“Only the good die young” may not have any basis in mortality science but the poor appear to die younger than the wealthy. So this is good news for those with smaller funds that will receive bigger annuities be cause of it. Or is it?

At Prudential, we are acutely aware of mortality trends and we include anticipated improvements in our mortality rates. We are certainly not “ignoring this factor on with-profits annuities”, as Mike suggests.

In the context of with-profits annuities, broadly speaking, if the anticipated imp rovements do not materialise, we will have more to distribute to surviving with-profits annuitants. How ever, if mortality is lighter than the allowance built in to our rates, then returns will have to be spread more thinly.

I cannot do better than quote from the Prudential&#39s own with-profits annuity literature, which explains what is happening here: “We determine initial starting pensions after taking into account what we believe to be a prudent view of future mortality levels. If, over time, we come to believe that this estimate was incorrect, then bonus levels will be adjusted.

“In deciding whether the estimate was incorrect, we will rely not only on data relating to the relatively small group of with-profits annuitants but also data in respect of the rest of our annuity portfolio and wider industry experience.

“Reversionary bonus levels are set to provide an underlying long-term guarantee to policyholders while still allowing the fund sufficient investment freedom to pursue a largely equity-bac ked strategy. Projections to determine suitable reversionary bonus levels will take account of mortality changes.

“Terminal bonuses will ultimately determine the actual payment to policyholders. These will be adjusted so that the differences in the number of lives surviving are appropriately reflected. In other words, investment returns will be spread over a larger or smaller number of people than originally expected and bonuses will be adjusted to compensate.”

This is how insurance works. This is how everyone can be guaranteed an annuity for life. The main influence on what that annuity will be is the returns on investments yet to be earned so there is bound to be an element of risk.

The reward for this risk is the prospect of income growth and the long-term “hedge against inflation” implicit in the with-profits fund backing. Retirement now represents a medium to long-term investment opportunity and with-profits investment has a good record of steady longer-term performance.

Retirees&#39 individual circumstances vary greatly, but the need for disposable in come is often greatest immediately after retirement. The retiree and spouse are more likely to be physically and financially active during this period.

The appeal of travel and other forms of expenditure tends to diminish over the years and the need for income can diminish with the advent of a quieter lifestyle. So the demand for as high a starting annuity as possible is not just a question of keen competition between the annuity pro viders. It is also a response to customer demand.

The example in Mike&#39s article is also fundamen tally flawed. He claims the rates available on conventional and non-profit annuities are closer than they should be. He has reached this conclusion because he has ig nored a vital aspect of annuity pricing, namely there is a cost to providing the non-profit annuity rate guarantee.

One of the reasons that this cost arises is that insurance companies are req uired to set up cautious actuarial reserves for these guarantees. But, you do not need to be an actuary to appreciate that there is little in this life that really comes for free. An advantage of the conventional with-profits product is that this cost simply does not arise. If the mortality basis on a with-profits annuity were guaranteed, this would come at a price.

Of course, it is possible that the “prophets of doom” may turn out to be right when the benefit of hindsight becomes available. No doubt, they would also delight in proclaiming “I told you so”.

But in the meantime, people retiring today need inc ome now. They must make sensible decisions based on their own circumstances and the information available today. With-profits annuities offer a natural home for the retirement income of many and I remain a lifetime supporter. As the football anthem goes: “Cheer up Peter Reid…”


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