Long Live Singaporeans: An Introduction to Annuities

I have been writing articles for several weeks now and all this while the attempt has been to simplify and demystify life insurance. Life insurance, put simply, manages the risk of dying too soon! But what about the risk of living too long?

Singaporeans have a longer lifespan than most other nationalities. One of the recent surveys suggests that average life expectancy of a Singaporean is over 83 years and it is expected to be north of 85 years in 2040! While that’s good news it raises a concern of funding the lifestyle post-retirement. And of course, an average life expectancy of 85 years implies there would be many people living well above 85 years and might live long enough to be the part of the centenarian club! The question then is, “how does one ensure that income is guaranteed even after retirement and till the time one is alive?” The answer, as you would have rightly guessed, is annuities!

Annuities, in simple words, are guaranteed income for the lifetime. There are many other ways to go about generating income for the lifetime but none of them is guaranteed because other instruments don’t hedge the insured against the longevity risk i.e. risk of living too long. Annuities, on the other hand, would pay regardless of when the individual dies.

Now that we know annuities are guaranteed income for the lifetime, they might look very simple. However, annuities, over the period of time have evolved and have several variations. I have identified the basic ones below along wit h their informal definitions. The graphs along with the definitions are aimed at aiding the understanding and may not be to scale.

· Immediate Annuity: it provides immediate income soon after the annuity product is bought. You pay a single premium which is paid back to you in the form of a series of payouts throughout the lifetime.

· Deferred Annuity: it has two phases: the accumulation and income phase. You build the corpus by paying a series of premiums during the accumulation phase and receive income for the lifetime once income phase kicks in, which generally happens at the retirement age.

· Escalating Annuity: While most annuities offer a guaranteed dollar amount as income, escalating annuities offer income that increases over a period of time. These annuities start with a relatively smaller amount (when compared to fixed income annuities) but increase with time by a fixed percentage thus protecting the policyholders against inflation.

To clarify, escalating annuities can be either immediate or deferred. I have taken the example of immediate version for the sake of illustration.

There are many more types of annuities and I would demystify those as well in near future. I hope that this introductory article on annuities helped you in getting a feel for one of the key insurance products used for retirement planning. In case you have any specific queries about annuities or life insurance in general, feel free to drop us a line at hello@fidentiaX.com. Additionally, I would be happy to respond to your queries on Twitter during #AskTheActuary session this Monday at 8 PM Singapore Time. In case you are unable to be online during the session, you can always tweet before the session and I would pick it up when I go live!

Disclaimer: The article has been written with an aim to broadly explain an otherwise complicated and technical topic for readers with little or no insurance background. Hence, it doesn’t have finer details but is still broadly correct. The readers are recommended to take advise from their respective financial advisers before taking any financial decision.

About the writer: Mr Sumit Ramani is the Chief Actuary of fidentiaX. He is a qualified Life actuary and a computer science engineer with over a decade of experience in (re)insurance business with focus on modelling of life and health products, peer review and business analysis.