THE CHILEAN ANNUITIES MARKET
Marco Morales, Roberto Rocha, Marco Morales, Roberto Rocha,
and Craig Thorburnand Craig Thorburn
Santiago, ChileSantiago, Chile
March 29March 29--30, 200630, 2006
Introduction
Annuities market analysis usually focused Annuities market analysis usually focused on few countries (US, UK, Australia) and on few countries (US, UK, Australia) and issues (adverse selection, thinness of issues (adverse selection, thinness of markets)markets)
Lack of sufficient analysis about Lack of sufficient analysis about determinants of performance (determinants of performance (MWRsMWRs, , annuity rate), especially in other countriesannuity rate), especially in other countries
Lack of sufficient analysis on regulatory Lack of sufficient analysis on regulatory issues, alternative institutional settings issues, alternative institutional settings
Introduction
The Chilean market is an interesting case to The Chilean market is an interesting case to study the development of markets for study the development of markets for annuities and annuities and PWsPWs, after its pension reform , after its pension reform of 1981of 1981
The large size of the market, and access to The large size of the market, and access to data due to strict disclosure rules, allows for data due to strict disclosure rules, allows for a more ina more in--depth examination of the depth examination of the performance of the annuities marketperformance of the annuities market
AN OVERVIEW OF THE CHILEAN MARKET: Growth
Insurance Premia: Total, Life, Non-Life, and Annuities(in % of GDP), 1990-2004
0.0%0.5%1.0%
1.5%2.0%2.5%3.0%
3.5%4.0%4.5%
1990 1992 1994 1996 1998 2000 2002 2004
Total Premia Life Premia Annuities Premia
AN OVERVIEW OF THE CHILEAN MARKET: Growth
Pension and Insurance Assets (% of GDP), 1990-2004
0
10
20
30
40
50
60
70
1990 1992 1994 1996 1998 2000 2002 2004
Pen
sion
and
Ins
uran
ce A
sset
s
0
5
10
15
20
25
30
35
40
Rat
io I
nsur
ance
/Pen
sion
s
Pension Funds Insurance Companies Insurance/Pension Assets
Chile Latin America
High Income OECD
Insurance Premium
4.6 2.2 7.9
Life 3.5 0.7 4.6
Annuities1.9 - -
PWs 0.5 - -
Other 1.1 - -
Non-Life 1.1 1.5 3.3
Insurance Premiums in Chile and Other Regions
AN OVERVIEW OF THE CHILEAN MARKET: Types of Pensioners
Year Total Normal Old Age Early Retirement Disability + Survivors
Number % of Total Number % of Total Number % of Total
1985 7,609 2,647 34.8% - 0.0% 4,962 65.2%
1990 57,119 23,876 41.8% 5,790 10.1% 27,453 48.1%
1995 190,400 55,591 29.2% 69,537 36.5% 65,272 34.3%
2000 343,965 93,152 27.1% 132,221 38.4% 118,592 34.5%
2004 520,793 133,343 25.6% 220,929 42.4% 166,521 32.0%
AN OVERVIEW OF THE CHILEAN MARKET: Menu of Products
LumpLump--sumssumsAccess conditions very restrictiveAccess conditions very restrictive
Phased Withdrawals (PWs)Phased Withdrawals (PWs)Regulated formula based on life expectancyRegulated formula based on life expectancyProvided by AFPsProvided by AFPs
AnnuitiesAnnuitiesFreely priced, but fixed, indexed, joint for marriedFreely priced, but fixed, indexed, joint for marriedProvided by Provided by LICOsLICOs
Temporary WithdrawalsTemporary WithdrawalsWithdrawal with deferred annuityWithdrawal with deferred annuityProvided by Provided by AFPsAFPs and and LICOsLICOs
AN OVERVIEW OF THE CHILEAN MARKET: Demand for Retirement Products
Year Total PWs TWs Annuities
Number % of Total Number % of Total Number % of Total
1985 7,609 7,373 96.8% - 0.0% 236 3.2%
1990 57,119 36,696 64.2% 148 0.3% 20,275 35.5%
1995 190,400 98,699 51.8% 6,803 3.6% 84,898 44.6%
2000 343,965 147,532 42.9% 6,632 1.9% 189,801 55.2%
2004 520,793 196,242 37.7% 6,193 1.2% 318,358 61.1%
AN OVERVIEW OF THE CHILEAN MARKET: Demand for Retirement Products
High degree of annuitization: 60% of all High degree of annuitization: 60% of all retiree annuitizeretiree annuitize
Higher percentage excluding disability and Higher percentage excluding disability and survivorship pensionssurvivorship pensions
Early stagesEarly stages——disabled and survivors disabled and survivors ““jumpstartedjumpstarted”” the annuities marketthe annuities market
1990s and 2000s: close connection between 1990s and 2000s: close connection between early retirement and annuitizationearly retirement and annuitization
AN OVERVIEW OF THE CHILEAN MARKET: Market Structure
Very concentrated Pension sectorVery concentrated Pension sector
Very competitive Insurance SectorVery competitive Insurance Sector
Differences in market structure reflected Differences in market structure reflected
in measures of market performancein measures of market performance
AN OVERVIEW OF THE CHILEAN ANNUITIES MARKET: MARKET STRUCTURE
Number of Life Insurance Companies, Annuity Providers, and AFPs, 1988-2005
0
5
10
15
20
25
30
35
40
1988 1990 1992 1994 1996 1998 2000 2002 2004
Life Insurance Companies Annuity Providers AFPs
AN OVERVIEW OF THE CHILEAN ANNUITIES MARKET: MARKET STRUCTURE
Market Concentration Ratios in Pensions and Annuities Herfindahl and Share of Three Largest Firms, 1988-05
0
500
1000
1500
2000
2500
1988 1990 1992 1994 1996 1998 2000 2002 2004
Her
find
ahl R
atio
0%10%20%30%40%50%60%70%80%90%100%
Shar
e of
3 L
arge
st
AFP Herfindahl Annuity HerfindahlAFP 3 Larges t Annuity 3 Larges t
AN OVERVIEW OF THE CHILEAN MARKET: Market Performance
Performance of the AFP SectorPerformance of the AFP SectorHigh average returnsHigh average returns
Fees have declined but are still too high (100 bps) Fees have declined but are still too high (100 bps)
Performance has been better for PW holders (lower fees)Performance has been better for PW holders (lower fees)
Performance of the LICO/Annuities SectorPerformance of the LICO/Annuities SectorVery high Very high MWRsMWRs and thin spreads in recent yearsand thin spreads in recent years
Questions about sustainabilityQuestions about sustainability
Strong capital buffer from initial years partially eroded, Strong capital buffer from initial years partially eroded, some decline in some decline in MWRsMWRs expected expected
MWRsMWRs will probably remain comparatively attractive if will probably remain comparatively attractive if industry does not become very concentratedindustry does not become very concentrated
Market Performance: MWRs
March 1999 March 2002 March 2003 March 2004 March 2005
All cases 0.978 1.080 1.036 1.064 1.062
- maximum 1.148 1.222 1.181 1.276 1.223
- minimum 0.755 0.872 0.872 0.876 0.706
Male, Age 55 0.981 1.081 1.056 1.036 1.042
Male, Age 65 0.996 1.098 1.066 1.042 1.067
Female, Age 55 0.994 1.105 1.056 1.060 1.064
Female, Age 60 1.021 1.120 1.066 1.074 1.083
Joint Life (Male 65, Female 60) 0.998 1.089 1.058 1.062 1.069
Premium up to UF1,000 0.980 1.078 1.045 1.068 1.067
Premium above UF3,000 0.997 1.099 1.047 1.075 1.071
Non-Guaranteed 0.990 1.092 1.045 1.071 1.073
Guaranteed 0.974 1.076 1.033 1.062 1.059
Without deferment 0.979 1.079 1.035 1.063 1.061
With deferment 0.974 1.080 1.036 1.067 1.064
Variable Coefficient t-statistic p-values Other Statistics
Constant 62.39 86.31 0.000 Dep. Variable: MWR*100
Age 0.41 45.70 0.000 No. Observations = 6,526
Log (premium) 1.62 22.07 0.000
Guarantee -0.13 -16.04 0.000 R2 = 0.639
Deferment 0.02 2.24 0.025 Adj. R2 = 0.638
Male 1.35 8.98 0.000 Prob. > F = 0.000
Female 4.02 40.59 0.000 Mean Dep. Variable: 104.9
2002 10.66 76.10 0.000 S.D. Dep. Variable: 5.60
2003 5.70 38.72 0.000
2004 8.25 58.67 0.000
2005 6.51 44.72 0.000
Main Determinants of MWRs
Austral. Canada Switz. UK 1 UK UK US 2
(James) (James) (James) (Can) (James) (Brown) (Brown)
Male, Age 55 - - - - 0.921 0.934
Male, Age 65 1.013 0.981 1.046 0.977 0.908 0.927
Female, Age 55 - - - - 0.928 0.937
Female, Age 65 1.002 0.976 1.037 0.979 0.907 0.927
Joint 0.988 0.980 0.985 0.981 0.987 - 0.929
MWRs of Nominal Annuities in Other Countries
MWRs of Indexed Annuities in Other Countries
Austral. Canada Switz. UK 1 UK UK US 2
(James) (James) (James) (Can) (James) (Brown) (Brown)
Male, Age 55 - - - - 0.867 -
Male, Age 65 - - - 0.887 0.854 0.822
Female, Age 55 - - - - 0.876 -
Female, Age 65 - - - 0.877 0.857 0.782
Joint - - - 0.880 - -
MWR ConclusionsHigh by international comparisonHigh by international comparison
More favorable for cases where the expected duration is More favorable for cases where the expected duration is shorter (e.g., older ages, males) reflecting less exposure shorter (e.g., older ages, males) reflecting less exposure of provider to market and longevity risksof provider to market and longevity risks
Higher for larger premiums suggestingHigher for larger premiums suggesting
Better market search by better educated, more Better market search by better educated, more sophisticated clientssophisticated clients
Lower unit costs more important than longevity Lower unit costs more important than longevity differentialsdifferentials
Wide dispersion of results within sample, particularly Wide dispersion of results within sample, particularly for smaller premium levels, is noticeable.for smaller premium levels, is noticeable.
Market Performance: Spreads (1)
Average Annuity Rate and the Risk-Free Rate (% p.a.)1993-2005
2%
3%
4%
5%
6%
7%
8%
1993 1995 1997 1999 2001 2003 2005
Annuity Rate (RV-04) Risk-Free Rate (PRC-20)
Market Performance: Portfolio Composition
1991 1995 2000 2003 2005 Government Sector 38.3 40.3 28.7 17.6 16.5 Financial Sector 23.0 28.4 45.1 37.6 34.6 Mortgage Bonds 13.9 18.6 24.2 18.8 12.8 Mortgage-Backed Securities 3.0 6.0 10.1 10.1 9.1 Company Sector 29.0 22.1 15.3 33.4 38.5 Shares 8.9 10.2 3.4 2.9 3.9 Bonds 20.1 10.7 10.7 29.3 33.5 Real Estate 7.8 7.7 7.4 7.3 7.5 Other Assets 2.0 1.5 3.6 4.1 6.8 Total 100.0 100.0 100.0 100.0 100.0
Market Performance: Commissions
Commission Rates (% of the Premium), 1990-2005
0%
1%
2%
3%
4%
5%
6%
7%
1990 1992 1994 1996 1998 2000 2002 2004
Market Performance: Spreads (2)
Annuity Rate, Adjusted Annuity Rate, Central Bank Bonds and Corporate Bonds (% p.a.), 1993-2005
2%
3%
4%
5%
6%
7%
8%
9%
10%
1993 1995 1997 1999 2001 2003 2005
Annuity Rate (RV-04) Adjusted Annuity Rate PRC-20 Corporate Bonds
Market Performance: ROEs
Returns on Equity (ROE) of AFPs and Life Insurance Companies (%), 1992-2004
-20%-10%
0%10%20%
30%40%50%60%
1992 1994 1996 1998 2000 2002 2004
ROE of AFPs ROE of Life Insurance Companies
5−eMain Determinants of the Average Annuity Rate
Fixed Effects with Robust Standard Errors; Total Panel Observations: 693R2 = 0.7995; Adj. R2 = 0.7890; F-Statistic = 76.2162 ; P-Value(F-Statistic) = 0.0000
5−e
5−e
Variable Coefficient Std. Error t-Statistic
C 3.0760 0.2187 14.0668
RF 0.3639 0.0209 17.4077
SOFI 0.0029 0.0009 3.1772
SOA 0.0086 0.0038 2.2509
LEV 0.0110 0.0039 2.7967
MSHARE -3.4900 0.5727 -6.0937
AP(EARLY) 0.0002 2.57 * 6.8931
CR -0.0441 0.0180 -2.4431
HER(EARLY) -5.1390 0.7219 -7.1191
Market Performance: Can the behavior of annuity providers be explained?
Measures of performance reveal a very Measures of performance reveal a very competitive/aggressive annuities marketcompetitive/aggressive annuities market
Use of outdated tables by providers unlikelyUse of outdated tables by providers unlikely
Serious governance problems unlikelySerious governance problems unlikely
Maybe providers counting on future interest rate Maybe providers counting on future interest rate increasesincreases
Maybe providers are adopting deliberately Maybe providers are adopting deliberately aggressive pricing policies to gain market shareaggressive pricing policies to gain market share
Some market adjustments likely, started alreadySome market adjustments likely, started already
PRODUCT REGULATION: Marketing
Some rules in the 1990s designed to ensure Some rules in the 1990s designed to ensure transparency and minimum market search transparency and minimum market search (minimum # of quotes) did not work very well(minimum # of quotes) did not work very well
Excessive dispersion of annuitiesExcessive dispersion of annuities
Excessive abuse with cash rebatesExcessive abuse with cash rebates
New Pensions Law passed in 2004New Pensions Law passed in 2004Introduces caps on commissionsIntroduces caps on commissions
Introduces innovative electronic quotation systemIntroduces innovative electronic quotation system
Should lead to more transparency, less dispersionShould lead to more transparency, less dispersion
Some problems still remainSome problems still remain
CONCLUSIONS, RECOMMENDATIONS, LESSONS FOR OTHER COUNTRIES
CONCLUSIONSCONCLUSIONS
The growth of the market for retirement products, The growth of the market for retirement products, especially annuities, has been impressiveespecially annuities, has been impressive
High competition of the annuities market have High competition of the annuities market have taken place through the annuity rate and broker taken place through the annuity rate and broker activityactivity
The reduction in broker commissions and illegal The reduction in broker commissions and illegal rebates in the 2000s enhanced the role of the rebates in the 2000s enhanced the role of the annuity rate annuity rate
CONCLUSIONS, RECOMMENDATIONS, LESSONS FOR OTHER COUNTRIES
CONCLUSIONSCONCLUSIONS
Market has performed well for consumers, as indicated Market has performed well for consumers, as indicated by the high by the high MWRsMWRs, higher than ratios in other countries, higher than ratios in other countries
High High MWRsMWRs can be explained by access to a diversified can be explained by access to a diversified supply of indexed instruments, and very competitive supply of indexed instruments, and very competitive environmentenvironment
However, questionable if However, questionable if MWRsMWRs can be sustained at can be sustained at current levels for a long period. Some decline to be current levels for a long period. Some decline to be expected.expected.
There is some evidence that dispersion of There is some evidence that dispersion of MWRsMWRs has has decreased with the new quotation systemdecreased with the new quotation system