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Appendix A Analysis of Market and Longevity Risk of Contingent Annuities

Executive Summary Under a contingent annuity contract, the contract holder is guaranteed fixed, lifetime payments if their covered assets are depleted. The covered assets can be depleted by negative market returns, contract holder withdrawals, or both. With contingent annuities, a contract holder can withdraw a fixed amount per year without affecting the benefit base, where that benefit base drives the guarantee and the payment of a claim under the contingent annuity contract. In a typical product, a contingent annuity contract holder can withdraw 5% annually for life from the covered assets starting at age 65. For a 65-year old that can expect to live an additional 19 years, on average, he/she can withdraw that 5% and could expect that the covered assets will be greater than zero in the absence of market volatility (i.e., 19 payments equal to 5% of covered assets will result in 95% of the covered assets being drawn down). As such, the contract holder is most concerned with living past their life expectancy -- their longevity risk. The contingent annuity protects the contract holder against this longevity risk. In this appendix, the Contingent Annuity Work Group (CAWG) analyzes the relative protection against market and longevity risks provided by this product from the contract holder’s perspective. Our intent is to show the relative protection provided by a typical contingent annuity product. If a contract holder chooses to independently manage their longevity risk by reducing their guaranteed payments, then the longevity risk protection would no longer be as large relative to the market risk protection. In the same respect, if a contract holder made excess withdrawals, with no impact on the guaranteed payment, then the protection from market risk would increase as a percent of the total risk protection. As described in more detail below, we simulated the payment of claims if a contract holder lives to the average life expectancy and also simulated the payment of claims if a contract holder’s life expectancy differs from the average by simulating a range of life expectancy scenarios. Both simulations assume a range of market return scenarios. In this example, the total accumulated claims paid by the insurer over the life of the contract were used to assess the market and longevity risk of these types of products. In the first simulation, a claim was paid in 19.8% of scenarios prior to year 19 (the average life expectancy for the modeled 65-year old male). The average size of the total claims paid by the insurer to cover the guaranteed payments was $40,064. When a range of life expectancy scenarios beyond average life expectancy was introduced into the analysis in the second simulation, the average total claim paid was $67,328, or 68% higher than in the first simulation. Looking at claims paid when lifespan exceeds the average life expectancy, the comparison of claims attributable to longevity risk versus market risk only is even more dramatic. For example, when life expectancy falls in the 95th percentile (i.e., the person will live 28 years past age 65 instead of the average of 19 years), the average claim is $146,013.

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