Getting more people to buy Life Annuity

A Central Provident Fund member, on reaching age 55, is required to keep a minimum sum of $99,600 in the retirement account, to be withdrawn in monthly instalments at age 62.

CPF pays an interest rate of 4 percent per annum on the balance in this account. Compared to the prevailing interest rate on other types of investment, this is an attractive rate.

The CPF member is allowed to withdraw a monthly sum of $790 at the age of 62, payable over a period of 20 years. This payout is funded by adding interest at 4% per annum on $99,600 for 7 years (i.e. from age 55 to 62), and drawing a monthly sum of $790 over 20 years, with interest being credited at 4% on the monthly balance in the account.

The CPF member is allowed to invest the minimum sum in an approved life annuity. The payout under the life annuity plan varies from $400 to over $500, depending on the insurance company that you buy it from, and some small differences in the features of the plan.

For example, the payout is $523 for a male and $490 for a female, under a popular plan offered in the market.

The attraction of a life annuity is that the payout is guaranteed for as long as the annuitant lives, and does not stop at the end of 20 years.

According to a Minister Lim Boon Heng, “If you buy a life annuity, the insurance company will pay you less each month … but it will have to pay you for as long as your live. And if you live till 100, they will have to pay till you’re 100”.

But many people do not expect to live to 100 years. They consider the lower payout (i.e. a difference of 34% between $523 and $790) to be big enough to deter them by buying the life annuity.

Actually, the payout under the life annuity (according to the popular plan available in the market) is likely to be higher than $523. The sum of $523 is the guaranteed minimum. The actual payout in each year may increase with the addition of a variable bonus, which depends on the investment yield of the life insurance fund.

Less than 5 percent of members reaching age 55 decide to buy the life annuity. The majority of the members decide to leave their money in the CPF to enjoy the attractive interest rate of 4%.

Those who buy the life annuity are probably convinced about the attraction of lifetime payout, and expect the actual payout to grow yearly with the variable bonus. They do their calculations (with the help of the insurance adviser) and opt for this plan.

The majority prefers the certainty of a higher payout of $790 for 20 years from age 62.

Difference in Payout

It is important to understand why there is a difference of about 34% in the payout under the life annuity plan (i.e. $523) and the plan offered by CPF (i.e. $790). This arises from 3 components:

• Interest rate
• Life expectancy
• Expenses

The CPF is able to guarantee an interest rate of 4% per annum over a period of 27 years, i.e. from 55 to 82 years.

A life insurance company offering the life annuity is able to guarantee an interest rate of, at most, 2.5% per annum. This is the net return that they can get by investing in secure government bonds.

This difference in interest rate accounts for a large portion of the difference in the payout. If the insurance company is confident of earning at least 4% per annum on their investments over the next 20 to 35 years, they can reduce the gap by 25 percent. The life annuity can pay about $720 a month (instead of $523). This will narrow the difference to only 9 percent (compared to $790).

Another factor is the life expectancy. The amount in the retirement account is drawn down over 20 years. The insurance company calculates the average life expectancy for an annuitant at age 62 to be about 21 years for a male and 25 years for a female. With better health, the life expectancy is expected to increase in future years.

The difference in life expectancy accounts for about 4 to 5 percent difference in the payout.

The remaining difference in the payout is accounted by the expenses and profit margin of the insurance company (estimated to be about 5%).

Life Annuity Administered by CPF

If the life annuity is administered by the Central Provident Fund, it is able to make a higher payout (say $750) compared to the life insurance company (i.e. $523).

This higher payout comes from the higher interest rate of 4 percent used to calculate the CPF administered life annuity and the saving in expenses and profit margin that is charged by the insurance company.

As CPF is now paying 4% on the balance in the retirement account, there is no added cost in offering this same investment yield under its CPF-administered life annuity plan.

With a higher payout that is within 5 percent of $790, more people can be convinced about the advantage of taking the CPF-administered life annuity and enjoy the benefit of the pooling of the longevity risk.

Risk Pooling

I need to explain the concept of pooling of the longevity risk, offered by a life annuity.

All purchasers of the life annuity implicitly agree to pool their longevity risk with the other annuitants. Those who die earlier leave behind the balance of their “balance” in the annuity fund, to be used to continue the payout to those who live longer.

Everybody hopes to live to a ripe old age, and to continue to receive the payout from the annuity fund. This is only possible through the concept of pooling. In this case, the retirement accounts of all the annuitants are pooled together and are not kept as separate accounts.

Death Benefit

It is possible for the CPF-administered life annuity to make a lump sum payout as a death benefit payable on the death of the annuitant. This payout can be (say) 12 months of the monthly payout.

To provide for this benefit, the payout under the life annuity may be reduced by about 5 percent (say $715 instead of $750). This death benefit may make the life annuity to be more appealing, and can be useful to contribute to the funeral expense.

Reduce the interest rate on retirement account?

It is possible for the government to encourage more people to take up a life annuity from an insurance company by making the retirement account less attractive, for example by reducing the interest rate to 2.5%.

In my view, this will be a negative approach. I prefer the more positive approach of making the life annuity more attractive by offering the same investment return of 4%.

Conclusion

To encourage more people to enjoy the benefit of risk pooling in a life annuity, it is necessary to offer an investment return of 4% in the life annuity.

This can be achieved by a life annuity plan that is administered by the Central Provident Fund.

Tan Kin Lian

The writer qualified as an actuary in 1975. He served as chief executive of NTUC Income for 30 years, prior to his retirement on 31 March 2007. During this tenure, NTUC Income had been active in marketing life annuities in Singapore and had more than 50% share of this market.