THE CHILEAN ANNUITY MARKET ABSTRACT Annuities in Chile derive solely from pensioners under the AFP system. Although retiring members are not obliged to purchase an annuity (a system of programmed withdrawals exists as an alternative), most do so before the normal retirement age (65 for men and 60 for women), transferring the balance of their pension savings account to one of 23 insurance companies in return for an immediate joint or single-life annuity. All pensions are indexed monthly to movements the Consumer Price Inflation (CPI) as they are denominated in Unidades de Fomento, or “UF”. As such, the annuity companies invest the majority of their mathematical reserves in UF-denominated securities, issued by the public sector - the Pagares Reajustables issued by the Chilean CENTRAL BANK, or private sector institutions, such as Bonos Hipotecarios, which are sponsored by the banks. At the end of 1998 the insurance companies held mathematical reserves in excess of US$9.7 billion, backing over 240,000 annuity policies. This compares with over US$31 billion in pension funds managed by the AFPs at the same date. Gross written premiums (GWP) on annuities in 1998 amounted to US$1.1 billion, which represented around 65% of all life insurance GWP that year. The vast majority (81%) of these arises from old-age retirement annuities, while the balance derives from disability and survivor’s pensions. Given the lack of long-term financial instruments to fully match the liability for contingent pension flows, the State supervisory body (SUPERINTENDENCIA DE VALORES Y SEGUROS) has implemented conservative minimum mathematical reserve and capital requirements for all annuity contracts. The regulations also govern the mortality table to be used and a maximum technical interest rate of UF+3% p.a., when investment flows and pension payments are mismatched. In practice, the majority of companies are fully matched for the first 18 years, or so of pension flows, creating a significant. reinvestment risk. This, combined with the competitive nature of the annuity market, involves insurance companies in an initial loss of around 8% of the premium when writing new annuity business. The MWR assessment of current annuity rates show that the expected present discount rate of the payout offered by the average annuity policy of a 65 year-old male in March 1999 was approximately 86.2% of the purchase price, when compared with the population’s mortality. 1
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THE CHILEAN ANNUITY MARKET
ABSTRACT
Annuities in Chile derive solely from pensioners under the AFP system. Althoughretiring members are not obliged to purchase an annuity (a system of programmedwithdrawals exists as an alternative), most do so before the normal retirement age(65 for men and 60 for women), transferring the balance of their pension savingsaccount to one of 23 insurance companies in return for an immediate joint orsingle-life annuity.
All pensions are indexed monthly to movements the Consumer Price Inflation (CPI) asthey are denominated in Unidades de Fomento, or “UF”. As such, the annuity companiesinvest the majority of their mathematical reserves in UF-denominated securities,issued by the public sector - the Pagares Reajustables issued by the Chilean CENTRALBANK, or private sector institutions, such as Bonos Hipotecarios, which are sponsoredby the banks.
At the end of 1998 the insurance companies held mathematical reserves in excess ofUS$9.7 billion, backing over 240,000 annuity policies. This compares with overUS$31 billion in pension funds managed by the AFPs at the same date. Gross writtenpremiums (GWP) on annuities in 1998 amounted to US$1.1 billion, which representedaround 65% of all life insurance GWP that year. The vast majority (81%) of thesearises from old-age retirement annuities, while the balance derives from disabilityand survivor’s pensions.
Given the lack of long-term financial instruments to fully match the liability forcontingent pension flows, the State supervisory body (SUPERINTENDENCIA DE VALORES Y SEGUROS)has implemented conservative minimum mathematical reserve and capital requirementsfor all annuity contracts. The regulations also govern the mortality table to beused and a maximum technical interest rate of UF+3% p.a., when investment flows andpension payments are mismatched. In practice, the majority of companies are fullymatched for the first 18 years, or so of pension flows, creating a significant.reinvestment risk. This, combined with the competitive nature of the annuitymarket, involves insurance companies in an initial loss of around 8% of the premiumwhen writing new annuity business.
The MWR assessment of current annuity rates show that the expected present discountrate of the payout offered by the average annuity policy of a 65 year-old male inMarch 1999 was approximately 86.2% of the purchase price, when compared with thepopulation’s mortality.
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I THE CHILEAN ANNUITY MARKET
The introduction of the AFP system in 1981 has lead to the gradual developmentof a competitive market for immediate annuities. This segment of the lifeinsurance market has come to represent over 65% of the US$1.7 billion in GrossWritten Premium (GWP) placed in 1998. More significantly, given the nature ofproduct, the mathematical reserves guaranteeing the future pension payments onthese annuities amounted to US$9.7 billion in December 1998.
Table N°1 provides details on the key variables of the annuity market over thelast 9 years (1991 to 1998) as published by the SUPERINTENDENCIA DE VALOES YSEGUROS1.
1. The AFP System
1.1. Pensions under the AFP System
The AFP system provides for disability, old-age and survivor’spensions, offering the member or his surviving dependants’ a choiceof three pension methods: Retiro Programado - Programmed Withdrawals – also referred to as
Systematic Withdrawals in the US or Income Draw-Down in the UK, Renta Vitalicia Inmediata - Immediate Annuities, Renta Vitalicia Diferido con Renta Temporal - Deferred Annuities with
Temporary Withdrawals.
In the AFP system, the annuity is an option.
Under the programmed withdrawal (PW) method, the funds are retainedin the member’s AFP account. It is the AFP which assesses the levelpension (in indexed units of account - Unidades de Fomento) each yearas an actuarial function of the member and dependants’ ages andsexes, such that the fund will be completely drawn down over theexpected remaining life-time. During this period the fund continuesto accrue the full returns generated by the AFP (less any expenses,if the AFP makes a charge). At any time, the member, or in the caseof his death, his dependants’ may opt for one of the other twomethods.
The immediate annuity is a pension method whereby the member agreesto transfer the balance of his pension savings account as a lump-sumpremium to one of the life insurance companies in return for a life-long guaranteed monthly payment (in this case indexed in Unidades deFomento) from the moment of signing the contract and the subsequentpayment of the survivors’ pensions, if applicable. This insurance
1 Information collated and prepared by the Departamento de Estudios, CONSORCIO NACIONAL DESEGUROS VIDA.
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contract is irrevocable and is based on a standard policyconditions, approved by the SUPERINTENDENT OF INSURANCE.
The deferred annuity with temporary withdrawal method entails membercontracting to receive a guaranteed annuity from a date in thefuture, as determined in the policy and retaining sufficient fundsin his pension savings account to receive a temporary income fromthe AFP to cover the period from the date of opting for this methodand the date on which annuity payments begin. There one importantof condition to this hybrid arrangement - the deferred annuity maynot be greater than 50%, nor less than 100% of the first temporaryincome payment.
In addition to the basic conditions, the SUPERINTENDENCY has sinceapproved a number of annuity riders: A guaranteed minimum period of payment, of say 5 or 10 years, Repayment of the initial capital – know as the “Refund” option in
the US, and the possibility of improving the contingent survivor’s pensions
above the legal 60% up to a maximum of 100% of the policyholder’spension.
A profit-sharing endorsement was approved in 1988, but was subsequentlywithdrawn.
It is important to note that the annuity option may only be taken bythose members who are able to contract an annuity which is greaterthan or equal to 110% of the State guaranteed minimum old agepension. This accounts for a large number of low-income members orthose with a poor contribution record, being obliged to draw a PW.
The following table summarizes the differences between the two basicoptions.
PROGRAMMED WITHDRAWAL ANNUITY
Member may change AFP or switch to anannuity.
Irrevocable contract.
Pensions are recalculated annually. Pension is fixed at theoutset.
The rate or return is not guaranteed. The rate of return isguaranteed.
No longevity insurance. Life-long payment ofpensions.
Managed by an AFP. Managed by an insurancecompany.
Gives rise to inheritance on death No rights to inheritance.Pensions tend to fall in time. Pensions are constant in
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real terms.
In addition to the above conditions, the PW differs from the annuityin the following aspects:
In determining the value of the PW, the AFP makes noconsideration for the cost of the contingent funeral grant (UF15or around US$450), payable on the member's death.
The rate of interest applied is based in part (80%) on thereturns made by the AFPs on the pension funds over the last 10years and the average annuity rate in the previous calendar year(20%) – the rate used this year is around 6% p.a. This compareswith the prevailing market annuity rates of around 5% p.a.
No consideration is given to expense margins, e.g. administrationcosts, brokers’ commissions (currently around 5%) profit margins(currently around 1.5%).
Until this year, the AFPs had not charged for administering theCCI, i.e. PW were beinf administered for free. This has sincechanged and half of the AFPs now charge either a fixed orpercentage commission.
Furthermore, other than the technical aspects, the convenience ofthe PW include:
The attraction of earning a better return in the short term onthe balance of the individual account than that offered by thelife office in the long term – the unit value of the pensionfunds rose by over 10% in real terms in the first half of 1999.
The attraction of retaining control of the balance of themember's account, in the case of early death - the balance up toUF4,000 (around US$120,000) is tax free when transferred as partof the member's estate.
The attraction of not having to draw down the full amount of thepension, something which is not possible with an annuity. Thisbenefit offers considerable tax advantages to members withalternative sources of income, permitting the accumulation of taxsheltered capital gains until a pension is drawn, or leaving thebalance to be paid over to the member's estate.
The potential of increasing the level of pension due to a changein the family group. For example, premature death of the spouseor the member himself will inevitably lead to a higher pensionfor the survivor than any offered under an annuity contract.
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In summary, the PW is a very competitive product when compared withthe annuity. However, it involves the member retaining both thelongevity risk and the investment risk, whereas with the annuitycontract both of these risks are ceded to an insurance company.
This means that the AFPs are seen as competitors of the insurancecompanies.
1.2. Early Retirement and the Bonos de Reconocimiento
Early retirement in the annuity market is of great importance. Thistype of annuity has come to represent over 70% of all annuities soldin the last six years, although this fell to less than 60% in 1998,due to market conditions. The following table shows the GWP placedin each type of annuity.
The possibility of retiring before the “legal” retirement age is alegal and financial quirk. A male member may retire before age 65if the balance in his AFP account is sufficient to purchase anannuity equal to 50% of his average wage over the previous tenyears. What’s more, if the balance is sufficient to purchase anannuity of more that 70% of the average wage, then the law allowsthe member to draw down the balance as a lump sum (Excedente de LibreDisposición). An added attraction of this is that the lump-sum isvirtually tax-free. With this, the early retirement option and the"Libre Diposicion" rule provide the member with a strong incentive todraw a pension as early as possible. In the main this is donewithout giving up work, opting for an early retirement annuity as asecond source of income.
Another important structural aspect of the AFP system is theexistence of the Bono de Reconocimiento and the possibility for themember to endorse the bond and sell it in the secondary market.
The "Bono" represents the periods of contributions registered in the"old system" by those employees who switched to the AFP System. TheBono is nominative, and is held by the AFP as part of the member'sindividual account. Its value is expressed in pesos at the date themember joined the AFP System, and it accrues a real interest of 4%p.a. The Bono and the interest accrued is payable the day the memberreaches the normal retirement age, or on death or being declareddisabled, and it is then paid into the Cuenta de Capitalización Individual.
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By trading the Bono in, the member can release a large part (stillamounts to over 60% in most cases) of his retirement savings tofunds the cost of the pension. Without this possibility, earlyretirement would be virtually impossible. As such, the developmentof the Chilean annuity market has benefited significantly from thisparticular system for funding the government obligation.
Recent calculations show that the Bonos outstanding, to be paid bythe government will add as much as US$12 billion to futureretirement funding.
1.3. Death & Disability Cover (The Group D&D Policy)
The death and disability (D&D) covers are provided under a specialgroup insurance contract, taken out by the AFP to provide a definedbenefit as, a percentage of average pay, to a member suffering from adisability or to his dependants in the case of death before thenormal retirement age (Normal retirement is taken to be 65 for menand 60 for women).
a) Disability Pensions
A member is entitled to a disability pension if, after beingevaluated by a specialized MEDICAL COMMISSION, he is found to havesuffered a permanent loss of more than 50% (partial disability)or 2/3rds (total disability) in working capacity.
The approval process is carried out in two stages, i.e. allinitial assessments are subject to a review after 3 years. Thedisability benefit is assessed as 50% (partial) and 70% (total)of average pay over the previous 10 years. During the first 3years, the company that underwrote the group D&D policy with theAFP at the time of the claim pays the pension, without touchingthe member’s balance with the AFP (or his Bono de Reconomcimiento).At the end of the 3-year period, assuming the MEDICAL COMMISSIONconfirms that the member permanently disabled, then the sameCompany pays the Aporte Adicional to the member’s AFP account.
This Aporte Adicional is equal to the difference between: Capital Necesario - the technical fund required to finance the
member's disability pension and potential survivors' pensionsfor his beneficiaries, based on the regulated mortalitytables and a long-term rate or interest, and
The accumulated balance (including the Bono de Reconocimiento)in the member’s AFP account.
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At this moment, i.e. after 3 years, the member is free to optbetween one of the three Pension Methods and may elect to purchasean annuity with the new (topped-up) balance in his AFP account.
b) Survivor’s Pensions
On death, the member's dependants have a right to survivors’pensions. These are determined as a percentage of the member’saverage pay: 42% for a widow without children. 35% for a widow while any children draw a pension. 10.5% for each child to age 18 or 24, if in full-time
education.The amount of the Capital Necesario is dependent on the actuarialpresent value of the contingent flow of the survivors’ pensionsand the company then pays the Aporte Adicional.
In both cases, the discount rate used in calculating of theCapìtal Necesario is the average market interest rate used by lifeinsurance companies for AFP Annuities in the calendar quarterimmediately prior to quarter in which the claim occurred.
The mortality tables have been defined by the SUPERINTENDENCY,based loosely on Chilean experience: MI85 (disabled mortality) B85 (beneficiaries’ mortality).
1.4. The Annuity Product
The following sums up the conditions of the annuity as a financialproduct.
Under an AFP annuity policy, the AFP member, or his survivingdependants, are the beneficiaries of an irrevocable insurancecontract that is underwritten by a registered life insurancecompany in Chile.
Insurance companies in Chile are divided into life and non-lifecompanies. However, the life insurance companies need not bespecialised in annuities, i.e. most tend to sell othertraditional individual and group products.
The benefit of this contract is the life-long receipt of indexedpension, denominated in Unidades de Fomento (UF), which is a legallyrecognized unit of account, the value of which is adjusted dailyin line with variations in consumer price inflation (CPI). Thepension is payable monthly in advance.
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The premium for this contract is a lump-sum, comprising thebalance of the member’s account in the AFP, together with thecash value of the Bono de Reconocimiento. This sum is paid at thestart of the contract.
The price of this insurance policy is expressed as a capital permonthly unit pension, for example, 149.5 units of capital perunit of pension, which is the average conversion rate at presentand which is determined freely in the market.
The purchase of an annuity can be made directly by the member orwith the assistance of independent brokers or company agents,giving a right to a commission, the amount of which is stated inthe policy document – average commissions are currently over 5.5%of the lump-sum premium.
All pension payments are made directly by the insurance company,i.e. the AFP has no further dealings with the members once hisbalance is transferred to the insurance company.
1.5. The Sale of Annuities
At the start of the AFP system, until 1988, there were very fewannuities sold. This was due, in the main, to two factors:
Until that date, all disability and survivors’ pensions were paiddirectly by the insurance company underwriting the group AFP D&Dinsurance risk, so these cases never came on the “open” market.
Members are not permitted to draw an old age retirement pensionduring the first 5 years in the system.
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The following table shows the number of annuity policies sold since1988
The investment of a lump-sum premium received on the sale of anannuity is directly affected by the regulations issued by theINSURANCE SUPERINTENDENT (SVS).
These regulations are designed to accomplish the following riskmanagement functions: Avoid excess exposure to any single asset class (for example,
over exposure to mutual mortgage units). Avoid excess concentrations within any single asset class (for
example, disproportionate holding in bonds issued by a particularcompany).
Eliminate certain classes of asset, which, due to the nature ofannuity liabilities, do not provide similar cash flows orprincipal protection features (for example, equities).
Ensure proper matching by maturity and cash flows of liabilitiesgenerated with selected assets.
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It is the last of these requirements, which creates the significantcapital "strains" found in the annuity business in Chile.
In the early years of the annuity business (prior to 1988), therewere few competitors in the market and all annuities were writtenusing the maximum technical interest rate of 3% p.a. real.Consequently, investment spreads were very large (4% or more).Asset selection, as a result, was concentrated in bonds and thecapital strain was not a real concern. In 1988, the INSURANCESUPERINTENDENCY introduced new technical reserve regulations(Regulaciones de Calce) aimed to encourage annuity companies to optimizethe matching of their asset and liability flows, by requiring higherrisk capital commitments when this did not.
The regulations allow a company to set up 80% of its technicalreserves using the market rate, in so far as the term of the assetsand liabilities are matched. The balance of 20% of the reservesmust, under all circumstances be valued at a conservative rate of 3%p.a. To do this, the regulations oblige companies to split allliability and asset flows into 10 periods ranging from 0 to 24months (Range 1) to 29 years and over (Range 10).
In practice, most annuity companies will be able to arrange for amatch of around 15 to 16 years, and some of the larger, moreestablished companies may do as well as 18 years. However, giventhe structure of investments available in Chile, none will becovered for period beyond 21 years, so creating a large degree ofreinvestment risk and obliging the companies to value the reservesconservatively and well below market rates.
Despite the lack of suitable long-term investment instruments, thematching has permitted companies to establish reserves at ratescloser to 4.5% p.a. real, allowing the companies to offer higherpensions. However, with commercial interest rates used for pricingannuities at over 5% p.a., there are still significant capitalrequirements. As a rule, a difference of 1% in the between thecommercial and matching rate will signify around 12% in capital costin writing a new policy.
Following these changes and with the arrival of more and morecompetitors in the annuity market, the financial spread has beenprogressively squeezed, falling from 2.6% in 1990 to a little over1% in 1998.
1.7. The Net Cash Flow of an AFP Annuity Policy
The net flows of income produced by the sale of an annuity productin Chile are complex and require some further explanation.
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The following example shows how, at the time a new policy iswritten, the company is required to recognize a loss of $20.8 of thepremium ($1,000). In addition, the owners will need to put up $71.1in new capital to ensure that the company’s leverage remains above1:15 times the liabilities.
Minimum Capital 102,1 97,5 92,9 88,2 83,6 78,9 74,2Dividends (Contributions)
(71,1) 32,0 30,6 29,1 27,8 26,3 24,8
Final Capital 102,1 97,5 92,9 88,2 83,6 78,9 74,2Investments 1.122,9 1.072,5 1.021,7 970,5 919,1 867,5 816,0Dividends (Contributions)
(71,1) 32,0 30,6 29,1 27,8 26,3 24,8
Capital to be recovered
(71,1) (39,1) (8,5) 20,7 48,4 74,7 99,4
Assumptions:
Premium 1,000 Initial Capital 0 Commercial Rate 5,06% Effective Matching
Rate4,78%
Broker's Commission 5% Return on
Investments7,00%
Initial Loss 2,08% Maximum leverage 15 times liabilities Debt / Equity Ratio 10
By the end of the first year, the investments, set up with premiumand capital, are projected to produce an income of $76.8 and the
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pensions paid out will have amounted to $90.3. However, as theannuitant is now one year older, the reserving requirements forfuture contingent pension payments are lower, allowing the companyto realise a non-monetary profit of $45.8, as a result of releasingpart of the technical reserve, which goes towards the companies netincome.
In the first year, the company is able to show a dividend of $32,which is made up of $27.5 from profits and $4.6 from a reduction incapital. The same situation is repeated in each of the susequentyears.
Considering a discount rate of 10% p.a. real, the dividends and therecovery of capital means that, under these conditions, theinvestment would ensure a payback period around five years.
1.8. Mortality Tables
The mortality tables used for all pension calculations in the AFPsystem are jointly regulated by the SUPERINTENDENTCIES OF INSURANCE (SVS)and AFPs (SAFP). As such, these are applied both in thedetermination by the AFP of the Aporte Adicional in the case ofdisability or survivors’ pensions as well as by life insurancecompany in rating and establishing the minimum technical reservesfor the annuities.
Right up until the early 1970s there Chile did not have a rtalitytable of its own. Most business was rated based on the US tables,for example, C.S.O.-1958The only approved mortality table at thetime was the M-70 K.W. This was a hybrid table derived from theexperience of the MUTUAL DE SEGUROS DE CHILE in the period 1957 to1969., and the which was published in 1972. This table still formsthe basis of most individual and group life insurance policiesissued in the market. In 1979, the M-70 K.W. table was used toderive the first annuity table – R-70, which was used for individualannuity products.
As of May 1981, when the AFP system began, the SVS created twospecial tables – R-81 and MI-81. The former (R-81) was constructed,based on a comparison of the prevailing most commonly used US tablesand the M-70 K.W., similar way to the way in which the R-70 tablewas created. The latter (MI-81) was done in a similar fashion, butcreating special loading based on US experience for the ages 0 to64, i.e. the rates after age 65 are the same.
These tables were extremely conservative, given the lack of any realunderstanding of the mortality of annuitants in Chile. Furthermore,the basis of the table was for males, so a female table wasartificially created by adjusting the male mortality, i.e. a female
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was assumed to have a mortality rate equal to that of a male sevenyears younger.
After three and a half years of the AFP system, the tables wererevised, leading to the introduction of the current tables:
a) Tables MI-85 H (men) and MI-85 M (women)
These tables are used in determining the mortality of disabledmembers in the AFP system, and forms the basis of themathematical reserves for the disability and survivors' pensioninsurance.
They were developed in the mid-1980's, and are based on:
General population mortality for South America, especiallythe 1970 census in Chile, as prepared by the CentroLatinoamericano de Demografia2 (CELADE), and consider 5-yearlyprojections of the population to the year 2025.
The experience of disability in the AFP system up until thatdate. Considering a small sample of 5,575 cases and therelative inexperience of the medical commissions indetermining disability in the early years, this element wasonly used to 'check' the table.
The mortality experience, between the years 1969 and 1979, ofdisability pensioners in the old Servicio de Seguro Social (SSS),the old social security system, covering about 35% of thelower paid population.
b) Tables RV 85 H (men) and RV 85 M (women)
These tables are used to determine the mortality of non-disabledpensioners under the immediate and deferred annuity pensionmethods. These tables are derived directly from the table R-81.
Table R-81 was, in turn, derived from the table M-70, whichis the prevailing table used in the group and individuallife insurance market, and adjustments based on comparisonswith the US table CS0 1958.
The 'new' RV-85 tables considered three major changes;
the separation into male and female tables,
increasing the maximum ages from 108 to 110, and
2 LATIN AMERICAN CENTRE FOR DEMOGRAPHY
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a revision of the new tables in the light of more recentCELADE experience.
c) Table B 85 H (men) and B 85 M (women)
These tables are used in determining the expected mortality ofnon-disabled surviving beneficiaries in the AFP system.
These tables are based exclusively on the same CELADE statisticsused in determining the MI 85 tables.
To-date all the tables have been non-selective, i.e. they are basedon national statistics, without any specific sector adjustments.However, their application in the AFP system is selective, as only apart of the population is represented under the AFP system.
The application of these tables in determining the minimum reservesfor all annuities involves a potentially high degree of adverseselection;
As indicated before, the better educated and higher socio-economic groups will tend to consider the Programmed Withdrawaloption more than the lower paid retiring members. In this case,the mortality of the lower socio-economic groups, due to theiraccess to health care facilities, work patterns and diet, willtend to be higher than the 'average' projected in the table.
The same can be said for those members who are unwell onretirement, i.e. whose own projection of their life expectancy isreduced. These members are likely to opt to stay with aProgrammed Withdrawal, so taking this group out of the risk pool.In this case, without these “good risks”, the average longevityof a life offices portfolio will tend to be higher than thatprojected by the population table.
The only exception to this is for those members who have not been inregular employment for most of their working life or who had beenself-employed for a important periods and who had not generatedsufficient funds in their account at retirement to generate apension greater than the Minimum Pension. In these cases, the memberis obliged to draw a Programmed Withdrawal equal to the MinimumPension until the balance of the account is exhausted. Only then doesthe State then start to pay the Minimum Pension.
The Minimum Pension is only payable, however, if the member has paidcontributions for at least 20 years. Only if member does not complywith this may he opt to purchase an annuity for a lower amount.
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This adverse selection will inevitably be a factor in the initialstages of any system. However, it is understood that the risk ofanti selection in a portfolio of annuitants reduces over time.
Over the last few years, the CHILEAN INSURANCE ASSOCIATION and theINSURANCE SUPERINTENDENCY have been working to develop a new table basedon the 18 years’ claims experience of the AFP system. The new table– RV-98 is expected to be introduced before the end of 1999. Thistable will be applied to all new contracts, i.e. it is not expectedto affect the value of the reserves for the existing portfolio ofannuitants.
The next project is the development of a table form rating theprogrammed withdrawals – work on this is already well under way.The motivation for creating such a new table is to ensure that thesecalculations are done more precisely, as they directly affect thecost of the State in providing the guaranteed Minimum Pensions.
1.9. Investment Regulations and Market Conditions
a) Legal Regulations
The law on insurance establishes obligations affecting theinvestment of technical reserves and risk capital. Thetechnical reserves constitute the funds that the company needsto hold at any time to guarantee that it can meet thecommitments made to policyholders in terms of insurancebenefits.
Risk capital is that part of the company's capital that isneeded to maintain the relationship between debt and capitalthat is established by the law. The law states that the valueof the technical reserves may not exceed 15 times the company'srisk capital. However, in practice, given the requirementsgoverning risk classification of all registered insurancecompanies, life insurance companies tend to keep the ratio wellbelow 12:1, so as to ensure a "A" rating.
A life insurance company's risk capital may never be less thanthe minimum capital of UF90,000, i.e. about US$2.7 million.
The principal investment restrictions (applying to lifeinsurance companies) are the following:
i) Type of Instrument
Technical reserves and risk capital may only be invested inthe following types of financial investments:
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(a) Certificates issued or guaranteed by the State orissued by the CENTRAL BANK OF CHILE.
(b) Time deposits or deposit certificates issued by banksor financial institutions.
(c) Letters of credit issued by banks or financialinstitutions.
(d) Endorsable mortgage loans.(e) Bonds, commercial paper, and debentures issued by
State-owned companies or private corporations.(f) Units in registered and authorised investment funds.(g) Equities.(h) Overseas investments.(i) Admitted and unexpired receivables for unearned
premiums.(j) Losses on the collection of current reinsurance
contracts.(k) Non-residential urban property, located in Chile.
ii) Portfolio Restrictions by Type of Instrument and Issuer
Investment of the technical reserves and risk capital maynot exceed the following percentage limits, according tothe type of financial instrument, shown as a proportion ofthe company's total investment portfolio:Investmentin:
Upper limit of:
(a) 50% of total.(b) 40% of total.(c) 40% of total.(d) 30% of total.(e) 40% of total.(f) 10% of total. (g) 40% of total.(h) 15% of total.(i) All of the reserves for current risks
and 10% of the risk capital of thesecredits.
(j) All of the claims reserves and 10% ofthe risk capital of these credits.
(k) 20% of total in the case of lifecompanies and 30% in the case on non-life companies.
b) Investments in the Market and Life Insurance Company Practices
The volume of premium and technical reserves in the life markethas grown considerably during the last decade, amounting to overUS$10.75 billion at the end of 1998. This growth has meant thatthis sector has acquired a significant proportion of the
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country's financial resources, and, given the constraintsindicated above, has had to invest these funds in the localmarket.
The following table indicates the volume and growth in lifeinsurance company investments in the last eight years:
Life Insurance Company Investments (1990 to 1998)Year Total Investments
(US$ Millions) Annual Rate of Growth(% on previous year)
The predominant financial instrument is the Bono deReconocimiento, the special Government bond issued to reflectthe State’s debt for contributions paid into the old pay-as-you-go system. These bonds offer a real rate of return of 4%p.a. and there is a relatively deep market for theseinstruments. At the end of 1998 the insurance companies heldover US$2.8 billion of these bonds, or 26.4% of their totalportfolio.
The next most important type of investment, which accountsfor a further US$2.6 billion, is Bonos Hipotecarios. These aremortgage bonds issued through a commercial bank and securedagainst residential real estate. This is the principalsource of the domestic home finance and, together with theAFPs, the annuity companies provide over 65% of this type offinance.
3 Including Real Estate, Investment Funds and Overseas Investments.
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CENTRAL BANK bonds account for around 12% of insurancecompany’s holdings with US$1.3 billion invested mostly inlong-term (8 to 20 years) Pagares Reajustables.
These three instruments account for 65% of all insurance companyinvestments, with the balance of the portfolio being held inmortgage loans (9.3%), the insurance company’s own real estate(7.1%), corporate bonds (6.6%), bank bonds and CDs (6.4%),equities (4.3%), mutual and investment fund units (1.7%) andothers (2%).
The following table indicates the average annual real rate ofreturn (in UF) generated by all the life insurance companies.This has been calculated as a function of the investmentearnings declared at 31st December each year, divided by theaverage of the investments under management during the period.
18
Life Insurance Company Annual Real Portfolio Yield (1990 to1998)Year Real Annual Return
Since 1995 all insurance companies have been required to be rated byat least two of the approved and independent Risk ClassificationCompanies on a quarterly basis. As an integral part of the recentcapital market reforms the terms and methodology to be used in thisprocess has recently been reviewed. The rating of each company arepublished by the SVS each quarter and the following table summarizesthe conditions at March 1999.
Rating Insurance CompanyAAA CHILENA CONSOLIDADA CONSORCIO NACIONAL CONSTRUCCION
AA+ AETNAAA ING VIDA, INTERRENTAS, ISE LAS AMÉRICAS, RENTA NACIONAL, SANTANDER, VIDACORP
AA- ALLIANZ-BICE, BHIF AMERICA, CIGNA, CRUZ DEL SUR, EUROAMÉRICA, MASSSEGUROS,PREVISIÓN, PRINCIPAL
A+ CNA A LE MANS DESARROLLO
A-Ai CGS, VITALIS
Ei
1.11. Commercialization of Annuities
In traditional life insurance, products are focused on protectionand/or replacement of income streams. In practice, few consumers ofthese products seek a company directly to provide these types ofcover, hence the saying, that “insurance is sold, not bought”. Withthis, insurance companies have tended to develop a range ofdifferent distribution channels through which to contact the publicand convince them of the need for such protection. Despite thecost, the majority of companies involved in these lines of businesshave developed a sales force of agents to place these products,
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given that this has proven to be the most effective means ofdistribution.
In the annuities business, however, the situation is significantlydifferent. On reaching retirement age or being declared disabled,the potential annuitant is actively encouraged to look for aninsurer and, given the complexity of the market, most of them electto use a broker or consultant to assist them in selecting the bestcompany. The use of direct sales forces in the Chilean annuitymarkets is not common practice, although some of the largercompanies do have them. The use of independent brokers is furtherenhanced in Chile, where the regulations oblige the annuitant topresent quotations from at least three different companies.
The principle elements determining the sale of an annuity via thebrokers in Chile are the level of commissions and the amount of thepension offered. Other factors, such as company size, reputation,solvency, service and national origin are of considerably lessimportance.
The commissions have increased considerably over the last few years,from around 1.5% of gross premium in 1988 to well over 5% today.This does not reflect a change in the services provided, but thedemand from the pensioner to get hold of a cash sum on retirementand, in effect, commute part of pension. The system does not allowthe member to take part of the balance as a lump sum (unless thepension exceeds 70% of salary). This being the case, the broker oragent is encourage to pay part of the commission over the topensioner as part of the “deal”.
1.12. The Evolution of the Market and its Providers
Overall, the life insurance market in Chile has grown consistentlysince the beginning of the 1980's, reaching a total premium ofUS$250 million by 1988. Since then, the market has expandedexponentially, largely driven by the sale of early retirementannuities, which has accounted for over 70% of all annuity sales inthe last five years. In 1998, the total life insurance marketpremium was US$1.7 billion, of which AFP annuities accounted for 65%or US$1.1 billion, in new business.
In terms of assets under management, Chilean annuity companies’reserves have risen from US$1.5 billion in 1988 to US$7.7 billion inDecember 1998. These are projected to increase at rates well inexcess of 10% p.a., rising to US$37 billion by the year 2010.
The evolution of the number of providers in the annuity market is aclear indicator of the lack of barriers to entry and the degree ofcompetitiveness. In 1988 there were 9 companies selling annuities,
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with the largest company managing 47% of the market – the largestthree companies held 87% of the market. By 1992 the number hadrisen to 20, with the largest company controlling 15% and thelargest 3 companies holding around 40% of the market. At the end of1998 there were 23 providers. The largest company had 11% of themarket and the largest 3 companies controlled less than 30%.
The annuity market is a highly capital intensive business andanother indicator of its rapid development is the growth in thevolume of risk capital invested by the owners of the companies inthe period. In 1988 the equity of the annuity companies amounted toUS$166 million. By the end of 1998, total equity was over US$1.15billion.
Ownership of the companies in the market is principally foreign.Table N°10 provides an overview of the ownership of the 23 lifeinsurance companies operating in the annuity business as at December1998, and their ties with the banking and AFP markets. There are 4wholly Chilean life insurance companies. The rest are either jointventures (9) or wholly owned subsidiaries of foreign companies (10).10 of the companies have close ties with a bank or the owners of afinancial group and 7 have ties with one or more of the AFPs, i.e.all but two of most of the 8 AFPs have related life insurancecompanies.
Given the regulations governing the nature of the product, theChilean annuity business is principally one of investment of thelump-sum premiums in the financial market. The mathematicalreserves are predominantly invested in fixed interest securities –in December 1998 only 4.3% of all investments were in equities.Over the last 10 years, the volume of investments managed by theinsurance companies has risen from US$1.6 billion to US$10.8billion.
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OWNERSHIP OF LIFE INSURANCE COMPANIES (DECEMBER 1998)
COMPANY NAME PRINCIPAL OWNERS COUNTRY OF ORIGIN
AETNA AETNA INTERNATIONAL USAALLIANZ-BICE ALLIANZ / BICE Germany / UKBHIFAMERICA BBV / BHIF GROUP / GENERAL AMERICAN Spain / Chile / USACGS VIDA USACHILENA CONSOLIDADA ZURICH LIFE SwitzerlandCIGNA INA / CIGNA USACNA CNA USACONSORCIO LEÓN / HURTADO Chile / ChileCONSTRUCCION CONSTRUCTION INDUSTRY GROUP / SUN ROYAL
ALLIANCEChile / UK
CRUZ DEL SUR ANGELINI ChileEUROAMÉRICA B. I. DAVIS / MAPFRE Chile / SpainING ING HollandINTER RENTAS AIG / ALICO USAISE LAS AMÉRICAS PENTA GROUP / SUN LIFE OF CANADA Chile / CanadaPREVISIÓN VIDA SECURITY ChileMASSSEGUROS INFISA/ MASS MUTUAL Chile / USALE MANS DESARROLLO LE MUTUELLES DU MANS FrancePRINCIPAL PRINCIPAL GROUP USARENTA NACIONAL ERRAZURIZ GROUP ChileSANTANDER SANTANDER GROUP SpainVIDA CORP GRUPO INFISA Chile / USAVITALIS LEÓN / HURTADO Chile / Chile
The expected number of potential annuitants has been projected usingdemographic data of members in the AFP system, and recent earlyretirement patterns.
The projected flow of annuitants over the period of is as follows:
2. The Money’s Worth Calculations on Annuities in Chile
2.1. Indexation
In making international comparisons of the Money’s Worth Ratio (MWR),the first special consideration of the Chilean annuity market isthat all pension payments are indexed to consumer price inflation(CPI), as they are denominated in Unidades de Fomento or UF. Thismeans that nominal annuities are not offered in Chile.
The UF is effectively a parallel currency – a Chilean (Ch$) pesodiscounted for inflation one month in arrears. The daily value inCh$ of the UF is calculated and published by the INSTITUTO NACIONAL DEESTADÍSTICAS (INE) based on the CPI in the preceding month, and isassessed as the rate of inflation in that month divided by thenumber of days in the following month.
2.2. Methodology
With the proviso that all annuities in Chile are indexed, the MWRhas been assessed in Chile following the guidelines prepared byJeffery Brown, considering the three types of products: a SinglePremium Immediate Annuity (SPIA), a Life Annuity with Period Certain(LAPC) and a Joint and Contingent Annuity (JCA).
Similarly, the annuity rates have been assessed considering malesand females separately and the male as the policyholder in the caseof the JCA. These have been done at three ages: 55, 65 and 75.
Three mortality tables have been used: that of the population as awhole, the prevailing mandatory annuity table (RV85) and therecently developed annuitant table (RV98). The population table hasbeen calculated by the INE as at 1996 based on the 1992 census. TheRV85 table has been in operation since 1985 and is the basis of allmandatory minimum reserve calculations for annuities. RV98 has beendeveloped over the last few years on the basis of the mortalityexperience of all annuity policyholders in the AFP system in theperiod 1983 to 1996. Cohort mortality tables have not bee derived,given the lack of reliable information on the population prior tothe 1955. Similarly, records on annuitant mortality (workman’scompensation) have only been held since the early 1970’s.
Due to market size and conditions we have only applied twoalternative rates of interest: the prevailing Central Bank 20-yearUF denominated bond rates and the rates offered on UF denominatedMortgage Bonds (Bonos Hipotecarios). The market for corporate bonds isvirtually non-existent and so we have been unable to consider thisrate as a proxy.
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All calculations have been carried out at the end of March 1999.
All annuity policies issued under the AFP system are registered withthe SPERINTENDENCIA DE VALORES Y SEGUROS - SVS (Insurance Commissioner) and thetechnical details of these policies are collated and published eachmonth. As such, good information is available on the number andtype policies sold, the average premium and average pension paid andthe average technical interest rate used by each company inassessing the regulatory technical reserves, which are thereforeestablished on a consistent basis. For this reason, the annuityvalues have been assessed based on the SVS data published for March1999.
The market annuity rates have been used to derive the values ofCa/Aa in the MWR formulae for each of the annuity types under reviewand represent the unit cost of each, i.e. the unit premium requiredto generate a life-long pension flow of UF1. This is effectivelythe reciprocal of the values used in earlier papers, where theannuity is shown as a proportion of a premium, say US$100,000.
The values are calculated based on the regulatory mortality tables –RV85 (H) for men and RV85(M) for women, and the real annual rates ofinterest available at the end of March 1999.
The results of the calculations are shown in Table N°1.
Table N°1 – Base Annuity Calculations – Chile – March 1999
Annuitant
Nominal,SPIA, WOG
Nominal,SPIA, 10YC
Real,SPIA, WOG
Real,SPIA, 10YC
Escalating, SPIA,WOG
Escalating, SPIA,10YC
Male 55 no no 658 640 no noMale 65 no no 830 771 no noMale 75 no no 1,144 929 no noFemale55 no no 599 591 no noFemale65 no no 732 704 no noFemale75 no no 978 873 no noJLS 55 no no 605 597 no noJLS 65 no no 740 712 no noJLS 75 no no 983 873 no no
The rates have been assessed using the market conditions publishedby the SVS for all annuity company transaction in March 1999.
Additional information on 20 annuity providers in the market hasbeen provided by the ASOCIACIÓN DE ASEGURADORAS DE CHILE A.G – the Chilean
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insurance association. This study was carried out on a consistentbasis for all participants, as at 30 March 1999 and considers thevalue of two types of annuities (simple and 10-year guaranteed) fora range of annuitants (a single male, a single female and a marriedmale) and differing rates of premium (UF1,000, UF2,000 and UF3,000)4.The only given condition in this study was the value of theintermediaries’ commission, which was set at 4% for the purposes ofthe exercise.
The results of this survey are used to show the degree of variationin rates between the larger and smaller providers and depending onthe size of the immediate premium. Despite having fixed one of thekey determinants – namely the commission, the annuity price can varyby over 12%. Furthermore, the study shows that this variation issomewhat dependent on company size, i.e. the prices of the largercompanies are around 1.5% less than the smaller companies. This isprobably due to the distribution of costs. As to premium size, thestudy shows that there is little variation between the UF1,000(US$30,000 and the UF3,000 (US$90,000) annuity quotes.
As indicated, the levels of commissions and the practice of rebatingto the annuitant are relevant in Chile and this factor has beentaken into account in assessing the MWR. The annuity payouts havebeen adjusted to account for an assumed rebate of 25% of the average5% paid in commission, i.e. all the payout values have been dividedby a factor of 0.98755.
2.3. Simulations
These annuity rates are tested against two sets of variables toproduce the basis for assessing MWR and adverse selection:
a) Two mortality tables:
The recently developed annuity mortality table – RV98 (seeTable N°3), which is based on the mortality experience ofall annuitants under the AFP system in the period 1983 and1996.
The population mortality table as at 1996 (see Table N°4),which was specially prepared by the INSTITUTO NACIONAL DEESTADÍSTICAS – INE, based on the results of the most recentnational census in 1992.
A comparison of the rates of these two tables and the regulatoryRV85 is provided in Table N°2.
4 UF1 = Ch$14,685.39 = US$31.09 as at 30 March 1999.
5 1 – (0.05*0.25)
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The CELADE has produced projections of the Chilean populationand five-yearly mortality tables based on the 1992 census.These rates are shown and compared with the life expectancy ofthe population and the RV85 and RV98 tables in Appendix N°3.
The conclusion of this analysis is that the RV98 table, which islikely to become the standard annuity table for setting upreserves for AFP annuities by the end of 1999, considers asignificant loading for the risk of adverse selection.
b) Two market rates of interest:
The prevailing real rate of interest offered on CENTRAL BANKbonds Pagares Reajustables - PRC (Government Indexed Bonds) with aterm of between 5 and 20 years.
The prevailing rate offered on bank sponsored Letras Hipotecarios(Mortgage Bonds) with a term ranging from 2 to 20 years.
These rates were published on 26th March 1999 in the newspaper ElMercurio.
Given that CENTRAL BANK bonds are not available for period of lessthan 4 years, the Government Bond rates used for the first fouryears correspond to the publsided market rates used to discountBonos de Reconocimiento. These rates have also bee applied duringthe first two years to account for the fact that there were noshort-term rates Mortgage Bond rates.
Details of the rates used are provided in Table N°3.
2.4. The MWR
The values for the MWR are effectively the rates in Table N°1divided by the rates in Tables N°2 and N°3.
The results are shown in Tables N°4.
2.5. The Interest Rate
The rate of interest used in determining the value of a givenannuity is calculated by each insurance company based on themarginal economic return to the shareholder, deriving from ananalysis of the projected contingent cash flows (premium, pensionpayments, broker’s commission, administrative expenses, adjustmentsto the mathematical reserves, investment returns, taxes, etc..).
The rate of return of each policy sold is registered each month withthe Insurance Superintendent.
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The average of the rates for each company are published and form thebasis for determining the discount rate to be used in assessing theCapital Necesario for claims for disability and survivor’s pensions ofactive members payable under AFP group insurance policies.
2.6. The Effect of Adverse Selection
Concern over the possibility of adverse selection in the annuitymarket is the prime motive for the recent review of annuitypolicyholder mortality in Chile.
The tables currently used in the annuity market - RV85 (H) and (M)– were developed soon after the AFP system came into being and wereintroduced in 1985, some 14 years ago. These tables were derivedfrom mortality experience of the Chilean population as a whole, asrevealed by the national census in 1982, with a projection to theyear 2025. As such the tables are not a select table, as might wellbe expected, firstly given that the AFP system does not apply to thewhole Chilean population and secondly that members may opt not toannuitize their pension savings on retirement.
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II THE MONEY’S WORTH CALCULATIONS OF ANNUITIES IN CHILE
The section present the findings of an analysis of the relative cost ofannuities in Chile, based on the detailed methodology prepared for the WORLDBANK.6 The basis of this study is to determine the Money’s Worth Ratio (MWR)as a consistent method of comparing the cost of annuities across internationalborders. Put simply, the MWR is the expected present value of an annuity’spayout stream divided by the purchase price of the annuity.
1. Indexation
In making international comparisons of the Money’s Worth Ratio (MWR), thefirst special consideration of the Chilean annuity market is that allpension payments are indexed to consumer price inflation (CPI), as theyare denominated in Unidades de Fomento or UF. This means that nominalannuities are not offered in Chile.
The UF is effectively a parallel currency – a Chilean (Ch$) pesodiscounted for inflation one month in arrears. The daily value in Ch$ ofthe UF is calculated and published by the INSTITUTO NACIONAL DE ESTADÍSTICAS(INE) based on the CPI in the preceding month, and is assessed as therate of inflation in that month divided by the number of days in thefollowing month.
2. Methodology
With the proviso that all annuities in Chile are indexed, the MWR hasbeen assessed in Chile considering three types of products: a Single Premium Immediate Annuity (SPIA), a Life Annuity with Period Certain (LAPC) and a Joint and Contingent Annuity (JCA).Similarly, the annuity rates have been assessed considering males andfemales separately and the male as the policyholder in the case of theJCA. These have been done at three ages: 55, 65 and 75.
Three mortality tables have been used: that of the population as a whole,the prevailing mandatory annuity table (RV-85) and the recently developedannuitant table (RV-98). The population table has been calculated by theINE as at 1996 based on the 1992 census. The RV-85 table has been inoperation since 1985 and is the basis of all mandatory minimum reservecalculations for annuities. RV-98 has been developed over the last fewyears on the basis of the mortality experience of all annuitypolicyholders in the AFP system in the period 1983 to 1996. Cohortmortality tables have not been derived, given the lack of reliableinformation on the population prior to the 1955. Similarly, records on
6 Annuity “Money’s Worth” Calculation Instructions – Created for World Bank by Jeffery R. Brown
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annuitant mortality (workman’s compensation) have only been held sincethe early 1970’s.
Due to market size and conditions we have only applied two alternativerates of interest: the prevailing Central Bank 20-year UF denominatedbond rates and the rates offered on UF denominated Mortgage Bonds (BonosHipotecarios). The market for corporate bonds is virtually non-existent andso we have been unable to consider this rate as a proxy.
An important consideration in developing the final results of the MWR wasto consider the fact that part of the broker’s commission is likely to berebated to the annuitant. In this way, the market rates need to beadjusted so as to treat the rebated commission as if it were acommutation of part of the capital, so improving the MWR. The prevailingaverage rates of commissions paid on annuities in March 1999 was in theorder of 5%. Were we to assume that a quarter of this commission wouldhave been “rebated” to the annuitant, the resulting effective pensionwould then need to be adjusted by a factor of 1.25%, i.e. by dividing theresults by 0.9875. Although this adjustment has not been made in thefigures we discuss below, this factor should be considered when makinginternational comparisons.
All calculations have been carried out at the end of March 1999.
All annuity policies issued under the AFP system are registered with theSPERINTENDENCIA DE VALORES Y SEGUROS - SVS (INSURANCE COMMISSIONER) and thetechnical details of these policies are collated and published eachmonth. As such, good information is available on the number and typepolicies sold, the average premium and average pension paid and theaverage technical interest rate used by each company in assessing theregulatory technical reserves, which are therefore established on aconsistent basis (see APPENDIX N°1 for aggregate market data). For thisreason, the annuity values have been assessed based on the SVS datapublished for March 1999.
The market annuity rates have been used to derive the values of Ca/Aa inthe MWR formulae for each of the annuity types under review and representthe unit cost of each, i.e. the unit premium required to generate a life-long pension flow of UF1. This is effectively the reciprocal of thevalues used in earlier papers, where the annuity is shown as a proportionof a premium, say US$100,000.
The values are calculated based on the regulatory mortality tables – RV-85 (H) for men and RV-85(M) for women, and the average real annual ratesof interest to discount the flow of pension payments for:
“early retirement annuities” – 5.39% p.a. for policyholders under age65 (men) or 60 (women), and
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“normal” retirement annuities” – 5.57% for policy holders above theseages.
The results of these calculations are shown in Table N°1 in APPENDIX N°2.
The rates have been assessed using the market conditions published by theSVS for all annuity company transaction in March 1999 – see APPENDIX N°3.
The ASOCIACIÓN DE ASEGURADORAS DE CHILE A.G7, has provided additionalinformation on 20 annuity providers in the market. This study wascarried out on a consistent basis for all participants, as at 30 March1999 and considers the value of two types of annuities (simple and 10-year guaranteed) for a range of annuitants (a single male, a singlefemale and a married male) and differing rates of premium (UF1,000,UF2,000 and UF3,000)8. The only given condition in this study was thevalue of the intermediaries’ commission, which was set at 4% for thepurposes of the exercise. The details of this study are included inAPPENDIX N°4.
The results of this survey show the degree of variation in rates betweenthe larger and smaller providers and depending on the size of theimmediate premium. Despite having fixed one of the key determinants –namely the commission, annuity prices can vary by over 12%. Furthermore,the study shows that this variation is only somewhat dependent on companysize, i.e. the prices of the larger companies are around 1.5% less thanthe smaller companies. This is probably due to the their relativelylower distribution of costs. As to premium size, the study shows thatthere is very little variation between the UF1,000 (US$30,000 and theUF3,000 (US$90,000) annuity quotes.
7 The CHILEAN INSURANCE ASSOCIATION
8 UF1 = Ch$14,685.39 = US$31.09.
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3. Simulations
These annuity rates are tested against two sets of variables to producethe basis for assessing MWR and adverse selection:
3.1. Two mortality tables:
The recently developed annuity mortality table – RV-98, which isbased on the mortality experience of all annuitants under the AFPsystem in the period 1983 and 1996.
The population mortality table as at 1996, which was speciallyprepared by the INSTITUTO NACIONAL DE ESTADÍSTICAS – INE, based on theresults of the most recent national census in 1992.
A comparison of the rates of these two tables and the regulatory RV-85 table is provided in APPENDIX N°5.
The CELADE has produced projections of the Chilean population andfive-yearly mortality tables based on the 1992 census. These ratesare shown and compared with the life expectancy of the populationand the RV-85 and RV-98 tables in APPENDIX N°6.
The conclusion of this analysis is that the RV-98 table, which issoon likely to become the standard annuity table for setting upreserves for AFP annuities, considers a significant loading for therisk of adverse selection.
3.2. Two market rates of interest:
The prevailing real rate of interest offered on Central Bankbonds Pagares Reajustables - PRC (Indexed bonds) with a term of between8 and 20 years – an average of UF+6.42% p.a.
The prevailing rate offered on bank sponsored Letras Hipotecarios(Mortgage bonds) with a term ranging from 2 to 20 years – anaverage of UF+7.02% p.a.
As will be seen from the tables, the variation in the rates of thesetwo types of bonds over the different terms is 0.6% p.a..
The results of these simulations are shown in Table N°2 of APPENDIX N°2.
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4. The MWR
The values for the MWR are effectively the rates in Table N°1 divided bythe rates in Tables N°2.
The results are shown in Table N°3 of APPENDIX N°2.
The following shows the MWR for a single male at age 65, considering thethree mortality tables, the risk-free and corporate bond rates and asimple single premium immediate annuity:
RISK-FREE BOND RATE(6.42%)
CORPORATE BOND RATE(7.02%)
RV-85 – current table 0.937 0.865
RV-98 – new table 0.926 0.878
General Populationtable 0.876 0.832
As a result, the next table shows the relative value of the annuity inrelation to the prevailing mortality rates (RV-85) and confirms that thenew table (RV-98) will be around 1% more expensive. On the other hand,it shows that in relation to the general population table, currentannuity rates consider around a 7% cost for adverse selection.
