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Annuities and Other Retirement Products
Although prudential regulations force insurance companies to maintain higher capital reserves to cover the mismatching at the longer end of the maturity spectrum, insurance companies face a significant reinvestment risk, which is aggravated by the steady decline in long-term real interest rates. By increasing their holdings of corporate and mortgage bonds, insurance companies have increased their exposure to credit and prepayment risks. Prepayment risk, in particular, has risen in response to the fall in interest rates. Insurance companies have invested in equities and real estate to increase the average duration of their assets and have raised short-term debt to lower the average duration of their liabilities, but these strategies have provided limited benefits in asset liability management. Managing longevity risk has also been a major challenge. Risk-sharing arrangements, whereby longevity risk is shared with annuitants, have not been used in Chile. The use of international reinsurance to cover the long tail of liabilities has been constrained by regulations that require localization of reinsurance assets, while local reinsurance has not been available at reasonable cost. In addition, the industry has had no access to riskhedging instruments, such as longevity bonds or longevity derivatives. Thus, insurance companies have fully assumed the longevity risk. Estimating future improvements in longevity has proved one of the most challenging tasks of risk management, especially dealing with data limitations in the tail end of the age distribution. Since 2007, the private sector, with the support of the insurance supervisor (the Superintendency of Securities and Insurance) and the World Bank, has tried to launch a longevity bond in Chile, but so far this effort has been unsuccessful. Insurance companies are required to use life tables prescribed by the regulators for determining their technical and capital reserves and for reporting purposes but are free to use proprietary life tables reflecting their own clientele for pricing and marketing purposes. Although companies are not allowed to ask personal questions on health history, they are allowed to price annuities freely and to differentiate risks by observable characteristics, such as age, sex, level of income, and accumulated account balance of retiring workers (income and financial wealth tend to be well correlated with educational levels, which in turn tend to be highly correlated with life expectancy). Although evidence indicates that insurance companies price their annuities according to the risk characteristics of annuitants, evidence also exists of aggressive pricing and marketing campaigns that result in thin financial spreads and increase the exposure of insurance companies to investment and longevity risks. AFPs do not bear either investment or longevity risk. These risks are assumed by holders of PWs. The introduction of multiple (lifestyle or