It should come as no surprise that increasing longevity poses challenges in countries with strong public pension systems. Spain, my native country, provides an excellent case study: streamlining the Spanish public pension system will be critical to safeguard its sustainability – and to provide much-needed supplemental income.
Life annuities present one answer, yet demand for annuities in Spain is lagging. In fact, the majority of insurers are unwilling to generate sufficient life annuity supply, both due to the challenges of longevity risk management and the high capital requirements under the Solvency II framework.
The traditional sales model also contributes to this stagnation. Put simply, to succeed, the process for selling life annuities must change in countries such as Spain. Life annuities should be offered only within a broader advisory process and as part of package of solutions. Instead, too many insurers present life annuities alone and push the sale of a product that, in itself, is difficult to market.
Success also requires greater education. Insurance customers must recognize that saving for retirement is a long-term commitment. It is necessary to diversify income sources, combining the public pension with private capitalization products, to generate replacement income when we are no longer active in the economy.
Meeting the Regulatory Challenge
The market for annuities has become more hospitable as state-sponsored measures seek to make public pension systems more sustainable in an aging world. Consider recent reforms to the Spanish public pension system, including the introduction of a sustainability factor (SF), the initial consequences of which will be visible starting in 2019. The SF adds two new variables to the calculation of the public pension – the intergenerational equity factor and the annual revaluation factor – to current considerations (retirement age, years of paying dues, and dues base).
These reforms acknowledge an unfortunate reality: the public pensions today's Spanish wage-earners can expect to receive will be lower than those of our parents. Therefore, if we want to maintain our standard of living, it will be necessary to save more during our working years to increase income in retirement.
The state has provided a favorable tax system to encourage purchase of life annuities. For example, starting at age 70, annuitants can expect a tax bonus of 92% in IRPF (individual income tax); the taxable base to be consolidated is 8% of the annuity received, reducing the actual tax rate to very low levels. The Spanish public pension system also offers a tax benefit on accumulated capital gains in the pension plans, with an exclusion of up to €240,000 for taxpayers over 65 as long as they reinvest those capital gains in a life annuity.
Classifications of permitted life annuities can be very extensive and flexible, and depend on payment frequency, beginning date of the annuity (deferred or immediate), and the number of people covered. Enhanced annuities are also possible; to qualify, the purchaser's state of health or medical history must be such that their life expectancy is lower than that of other annuity purchasers.
Meeting the Demand Challenge
So, why then isn’t there higher demand for life annuities in Spain? There are three causes: lack of a savings culture, lack of an advisory process that emphasizes educating the consumer as well as selling the product, and lack of competitive offers from the insurance companies themselves.
The objective of this article is not to study, in depth, the absence of a savings culture in my native country; however, I do want to highlight the need to develop a basic understanding of finance and a culture of preventative savings. From my point of view, companies should place the sale of life annuities within a process of advice to the customer. It is necessary to sell life annuities as an answer to a need, complementing the income of a future public pension. It also will be vital to understand if the client is close to accessing funds saved throughout his or her working life.
The advisor must understand each client's financial situation and goals. Does he or she expect an immediate predetermined future income? Or does the client plan to build savings in order to receive that additional income in the future, either through a deferred annuity or the combination of savings products with an immediate life annuity on the retirement date? In any case, it is always important to ask the client what level of net income he or she expects to enjoy in the future.
Additionally, there is a general perception that life annuities are purely actuarial, a financial strategy that cannot enable an earner to leave capital to heirs as inheritance. Nothing could be further from the truth. It is important to dispel this myth by asking insureds about funds they wish to leave to their heirs, and then to select the recommended annuity accordingly.
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