Are There Opportunities for Insurers in the Retirement Market

8/13/2019 Are There Opportunities for Insurers in the Retirement Market

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Are There Opportunities for Insurers in the

Retirement Market?Lyndon F. Fadri, FASP, ASA(Presented during the 48thAnnual Convention of the ASP)

1. Objective

Most corporate retirement programs are presently funded through trust

accounts with banks and trust corporations. Why is it so?

There have been significant developments affecting the design and

funding of retirement programs as well as accounting of costs

associated with these programs. Did these developments create

opportunities for insurers to gain a bigger share of the corporate

retirement market?


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This paper aims to give a comprehensive understanding of the market,

the dominant funding vehicle and the possible insurance products for

these programs to help members of the society working in life

insurance companies in evaluating whether there are market

opportunities or not, and if there are, some insights on how to take on

these opportunities.

2. Recent Developments

In December of 2006, the Insurance Commission issued Circular No.

41-2006 prohibiting life insurance companies from accepting deposits

not intended for payment of future premiums. This, for all intents and

purposes, prohibits group deposit products used by some companies to

fund retirement programs and limits the capacity of the premium

deposit fund rider or similar riders to supplement the limitations of

permanent plans in funding such programs.

In recent years, life insurance companies began underwriting variable

life insurance. The product is seen as a potentially good alternative for

retirement funding given that only the cost of insurance is subject topremium tax.

Interest rates have fallen and that means a reduction in the absolute

difference in the yield between a tax-qualified and non-tax-qualified

investments.

In 2005, the Philippine Accounting Standards No. 19 (PAS 19) was

implemented. PAS 19 requires, among others, fair valuation of assets,

comprehensive financial disclosure that includes the fund movement

and an actuarial valuation even if a company has no formal retirement

program.

Plan assets are expected to fluctuate depending on the movements in

the economic environment. The recent decline in interest rates sent

retirement trust fund values soaring registering returns higher than

20%. This further strengthened the position of trust funds in the market

as compared to insured plans. Insured plans may regain some

marketing grounds though if interest rates increase or fluctuate

significantly.

The disclosure of the movement in the plans asset exposed another

major weakness of permanent plans used for retirement funding given

that the fair value of group permanent policies is measured (aspracticed by most pension actuaries in the country) as the higher of the

following:

cash value; or

present value of benefits less the present value of future gross

premiums using PAS 19 prescribed discount rate which is

normally higher than the plans' internal rate of return.

In an extreme case, a newly-issued regular-pay group policy with no

benefit payments yet would exhibit no value at all even if premiums have


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been paid.

Actuarial valuations are no longer regarded as a cost associated with

the setting up and maintenance of a retirement program, thus,

effectively reducing a disincentive of having a retirement program.

Finally, while PAS 19 does not require funding, it made employers

without retirement programs yet conscious of their retirement liability

and the need to set up such programs. With the proper recognition o

liability, decision to set up a retirement program may be a lot easier as

it would only require conversion of such liabilities to contributions

(balance sheet items) as opposed to starting without any provision at

all. The immediate recognition of the increase in vested benefits as

expense should also help hasten setting up of retirement programs.

We have observed a 40% increase in the average number of new plans

set up for the past couple of years over the three-year period prior to

PAS 19 implementation.

On a global perspective, defined contribution programs continue to

reign. The collapse of big multi-national companies made globamanagers more wary of risks that include the DB program risk. We

have observed local subsidiaries feeling greater pressure from their

parent companies to shy away from DB programs, or to stop accepting

new members into an existing DB program or completely shift to a DC

program. However, stopping a DB scheme or shifting to DC has been

difficult considering the existence of the law on diminution of benefits. In

addition, with R.A. 7641, the risks associated with a DB scheme are

not completely extinguished.

3. Survey of Plans Marketed by Insurance Companies: Past &

Present

A survey of (15) life insurance companies shows that four (4) do not

offer any product for funding corporate retirement programs while ten

(10) offer permanent plans. Most of the ten, however, do not really

market this product aggressively but just accommodate proposa

requests from agents. The same is true for the two (2) companies using

their variable life plan.

Those that offer GUL plan, GVL plans and/or GYRT packaged under

trust are the ones really serious in pursuing corporate retirement

business.

Product Number

Permanent Plans 10

Universal Life 1

Group Universal Life 2

Variable Life 2

Group Variable Life 1

GYRT + Trust 1


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Of the fifteen insurers, three (3) did not offer any and another three (3)

have not de-listed any product to support corporate retirement plan

funding.

The table below shows the products that were previously offered by

some insurance companies but were de-listed. Delisting of the PDF-

supplemented plans was due to IC Circular No. 41-2006.

The company that marketed Permanent Plans as a component of the

Trust Agreement stopped selling the product for reasons discussed in

later sections.

DAF / DAC was de-listed, most probably, due to lack of new business

coming in either as a result of the lack of support from the agency force

and the marketing managers (no premium credits, low agency

compensation) or the lack of competitive edge versus funding using

trust agreements.

Product Number

Permanent Plans + PDF 7

Permanent Plans + Trust 1

GYRT + PDF 2

DAF / DAC 3

4. Dissecting the Market

4.1. Program Types

In general, there are three broad types of Retirement Programs:

Defined Benefit (DB), Defined Contribution (DC) and their

combination Defined Contribution with Minimum Defined Benefit

(DC-DB).

In the country, DC programs are essentially DC-DB programs

because of R.A. 7641. It is also the primary reason why DB

programs are prevalent estimated to be more than 95% of basic

retirement programs.

Some employers put up a contributory DC program to supplementthe basic DB plan. This supplementary DC plan may have a good

potential for growth if administrative costs are brought down to

more affordable levels. DC programs require maintenance of

member account balances which means that contributions should

be recorded individually and earnings be allocated equitably to

each member. Members are also provided with their account

balances.

4.2. Benefit Payment Options


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Benefits under retirement programs in the country are usually paid

in lump sum. Seldom that a program pays pension or offers

annuity options. Employers normally want to be released of their

obligation to the retiring employees immediately and be free from

extended risk and further administrative burden.

This situation coupled with the employees general preference for

lump sum benefits (if an annuity option is available to retiring

employees, the lump sum payment is usually chosen even if the

annuity value is actuarially greater than the lump sum) practicallyshuts out potential annuity business for insurance companies.

4.3. Market Segments

Clients may be broadly classified according to size or more

precisely, the volume of its current and expected retirement fund.

Investment parameters usually vary with size.

Clients may also be classified based on their risk appetite: the

ultra-conservative, the conservative and the less conservative.

4.4. Independent Actuaries

Independent actuaries are important players in the market.

Actuarial valuation / certification by an independent actuary is a

required submission by the Bureau of Internal Revenue (BIR) for

tax-qualification purposes. Many plan sponsors also prefer

actuaries who are independent of the fund managers.

4.5. Other Business Characteristics

Persistency of accounts is very high at least for trusteed plans andeven for the appropriate insured plans. There is not much transfer

of accounts from one trustee / insurer to another.

Gestation period is usually longer compared to other employee

benefits such as hospitalization and life insurance benefits

Retirement programs are usually put up only after the company

has operated for a considerable period.

4.6. General Considerations in Choosing a Funding Vehicle

From experience, plan sponsors consider some or all of thefollowing in choosing a funding vehicle and the trustee or insurer

itself:

Tax Qualification

There are three (3) incentives for tax-qualified plans as follows:

retirement benefits are not subject to tax provided the

retiree is at least 50 years old and with 10 years of service

contribution to the retirement fund is a deductible expense


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Studies

COMMENTS &

RESPONSESValuation of

Hybrid Retirement

ProgramsRead More

PDEX: APPROPRIATE FOR

IAS/PAS 19

VALUATIONPDEX rates

should be accepted as a valid

reference rates in setting the

discount rate because there is

no deep market of zero-

coupon bonds. Granting that

we really need to use zero-

coupon bond rates, equatingthe zero-bond yield with the

coupon-paying bond yield is a

valid method.Read More

VALUATION OF HYBRID

(DC/DB)RETIREMENT

PROGRAMSIt is NOT right

to treat hybrid (DC/DB) plans

as pure defined benefit plans.

PROGRAMS Read More

WHAT IS THE BESTFUNDING VALUATION

METHOD?If valuations are

done with intervals of say three

(3) or more years, the

Aggregate Entry Age Normal

is the better method to use.

Read More

WHY NOT PRE-NEED

PLANS FOR CORPORATERETIREMENT

PROGRAMSPre-need plans

could not provide the exact

benefits as a multiple /

percentage of final monthly

salary per year of service and

more. Read More

ARE THERE

OPPORTUNITIES FOR

for corporte income tax purposes (contribution towards the

current service cost is immediate while contributions in

excess is spread over 10 years), and

investment income of the fund is not subject to tax.

Some funding vehicles are not given all of the three incentives even

if qualified by the BIR.

5. The Dominant Funding Vehicle

Most retirement programs are under trust with banks and trust

corporations. Some employers create their own board of trustees but

still usually use these financial institutions to manage the investments.

Under this funding vehicle, contributions are remitted to the trustee who

invests the fund, disburses benefits and performs other administrative

functions. The trustee does not guarantee interest, not even the

preservation of capital. It charges a fee which is usually a percentage of

the retirement fund presently ranging from 0.5% to 1% p.a. depending

on the volume of the fund. Some charges a minimum flat fee per annum

e.g. P 10,000.

Most big banks require a minimum amount of placement ranging from P

1 million to P 10 million. Smaller ones accommodate lower amounts

but such funds are usually placed in special saving accounts or pooled

funds and the returns are usually lower.

Most banks and trust corporations do not accept or are reluctant to

accept DC administration functions and thus, usually done by another

party. The charges are usually in terms of a flat fee per contract plus a

fee per individual.

The biggest advantage of a trusteed plan is its full tax qualification. The

incentive on investment income may need a closer look, however. It is

not all encompassing. Some investments are taxed at source. These

include equities traded in the stock market and government securities

taken from the secondary market.

Investment strategy is usually simply aligning with the clients risk

appetite through a variation of the mix of fixed-income securities and

equity. Asset-Liability Management and Risk-Return Analyses are

seldom employed.

The trusteeship service is marketed through salaried employees.

6. Insurance Plans and How They Compare with Trusteed Plans

Insurers have inherent capacities not available to banks and trust

corporations:

their capacity to provide guarantees;

their capacity to offer other employee benefit products (life,

accident and medical) and even package them in a single policy;

and

their actuarial expertise

On the other hand, insured plans, even if qualified by the BIR, do not


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INSURERS IN THE

RETIREMENT

MARKET?This paper aims to

give a comprehensive

understanding of the market,

the dominant funding vehicle

and the possible insurance

products for these programs tohelp members of the society

working in life insurance

companies in evaluating

whether there are market

opportunities or not, and if

there are, some insights on how

to take on these

opportunities.Read More

get all the tax incentives. In addition, insurance products have their

respective weaknesses as discussed below.

6.1. Permanent Plans

As stand alone funding vehicles, permanent insurance plans do not

qualify for tax incentives. They also have the following

disadvantages:

They do not fit and are not flexible to meet the requirement

of a well-defined retirement program. Retirement benefits

under DB programs are set as a multiple of final salary

Permanent plans are usually soldby setting the maturity

value equal to the projected retirement benefit using a

asalary increase assumption. In reality, no assumption

woul dhold for a lon gperiod of time and the maturity value

value couold either be greater or less than the retirement

benefit. If it is greater, it means the employer spent more

than it should. If it is less, there is a problem issuing

additional coverage in small incremental amounts.

More problems come when a program provides for

ancillary benefits: early retirement, vesting benefits and

even death and disability benefits all of them usually set

as multiple of final salary and some even multiplied further

by a vesting factor that depends either on tenure, age or a

combination thereof. There is no way that face amounts

could be set so that cash values would equate with these

benefits for all durations.

Prior to the issuance of IC Circular No. 41-2006, this could

be managed to some extent with the Premium Deposit

Fund Rider or other deposit riders.

Returns are negative in the early years and still minimaleven if held to maturity. It takes several years for cash

values and dividends, if any, to exceed the premiums paid

and even if continued to maturity, the actual return to the

client is minimal (probably up to 50% lower than the

pricing interest) because of the expenses, taxes, agency

compensation and profit margins included in the

premium.

Worse, a big portion of the employee force separates prior

to retirement.

Permanent plans do not allow funding flexibility.PRemiums hsould be paid when due, otherwise, the non-

forfeiture options will apply. In contrast, under trust

employers may contribute depending on the availability of

cash or on its tax position.

Membership could be limited by underwriting

requirements.

As such, in general, permanent plans do not suit as retirement

funding instruments.


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6.2. Group Universal Plan

Group Universal Life (GUL) Plans presently marketed in the

country is simply designed like a Group Yearly Renewable Term

(GYRT) plan with a deposit rider except that contributions come in

as premiums.

GUL Plans provide a contrasting alternative to trusteed plans

because it guarantees interest and should find a niche in

conservative or small companies. The guarantee feature has

become more distinct with the market valuation of trust fund

assets. We now realize that even government securities are not

totally risk-free because their prices fluctuate.

The product has the following disadvantages:

Investment income subject to tax

The differential earnings of tax-qualified investment may be

covered or minimized by the following:

a) increased investment in equity and securities

whose earnings are not taxed at source butthrough corporate income tax

b) lower management fee as the fund need not be

managed separately from the general investible

funds of the insurer

If there remains any differential, it may be justified as the

price to pay for the interest guarantee.

Premiums subject to tax

Unless the company is exempted from premium,

documentary stamp and local government taxes, or unlessnon-exempt companies find ways to address this, this

product may not be competitive for DB programs.

For DC programs, crediting of a declared interest rate could be

much easier than the determination of NAV (applicable to both

Trust Funds and Variable Life Plans) so that administration could

be much easier and that should translate to lower administrative

fees.

The interest guarantee becomes more important for both the

employer and the employee. On the employees side, who receives

the benefit and spends it (as compared to investing it), it would be

hard to accept a low NAV amidst rising cost of commodities (in a

high-interest rate scenario). For many employers, steady earnings

are better than higher but fluctuating earnings.

6.3. Deferred Annuity Contract

While it is basically an annuity product, it can actually be looked

at as a deposit product with an option to buy annuity upon

separation or deferred annuity upon vesting. Ingenuous insurers

could probably make this a rider to the GYRT to create an

impression of a comprehensive employee benefit package.


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It can thus be compared to a GUL plan without the taxes on

premium but with less favorable tax incentives contributions are

deductible as legitimate business expense only upon purchase of

the annuity or payment of the benefit to an employee.

6.4. Group Variable Life Plan

Ideally, if the Group Variable Life Plan should support a well-

defined DB and employee-benefit program, its insurance

component should operate like the GYRT (adjustable cost of

insurance, uniform mortality charge per group, etc.) and the fund

portion should be accounted per group.

The group variable life plan may be able to compete head on with

trusteed plans given that only the cost of insurance is subject to

premium tax. Being too similar with trusteed plans as far as

investment is concerned may not help unless its strengths

(capacity to provide comprehensive employee benefit package and

actuarial expertise) are emphasized and the following inherent

weaknesses are addressed or minimized:

Premium Charge & Investment M anagement Fee

As mentioned above, trusteeship fee is 0.5% to 1.0% o

the fund. Other than the investment management fee o

expense charged to the fund, variable life plans have

premium charges ranging from 4% to 6% of the premium

that goes to the fund. There could be some room for

reduction in the premium charge as fund accounting would

be on a per-company basis. Fund pooling should create a

bigger fund that should result to lower investment

management expense or fee in terms of percentage of the

fund.

Significant portion of the premium charge is agency

compensation and may need to be re-evaluated if this plan

is to be marketed as a retirement funding vehicle.

Investment income subject to tax

The maximum differential between a tax-qualified fund and

a non-qualified variable life fund is 20% of the return e.g. if

interest rates stand at 6% p.a., this is roughly 1.2%. This

should be less if portion of the fund is invested in stocks

traded in the stock market.

Because the Variable Life fund is separate from the

general assets of the company, there may be a possibility

to get tax qualification by creating a distinct fund solely fo

tax-qualified programs.

Variable Life Plans could support a DC program very well because

of its inherent facility to allocate funds and earnings to individual

members. It may still be good, however, to issue a group contract

with its insurance component operating like GYRT. Acceptance of

monthly top-ups in small amounts is necessary.

Noting that employers spend extra for administering a DC plan


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usually through a third party, the premium charge could be readily

justified. That leaves the tax on investment income and

management fees as the remaining weaknesses of the product

which could be counter-balanced with the following strengths, if

managed:

life insurance packaging

choice of funds under current DC setups, members do not

have a choice of funds

Of course, it would be ideal if the variable life fund is tax-qualified.

6.5. Other Variable Life Plan Variations

Providing guarantees on the variable life fund would make the plan

distinct from Trust Plans and avoid apple-to-apple comparison. As

with the GUL, charges exceeding the trusteeship fee of banks

could be looked at as a price to pay for the guarantee.

Another variation is the provision of a fixed account although it

really depends on whether the fixed account would be subject to

premium and documentary stamp taxes or not. If it is, the only

advantage it adds is flexibility in the choice of funds.

7. Insurance Plans under a Trust Setup

Insured plans may be considered investment vehicles under a trust

setup. This should be easy for insurance companies with affiliate or

affiliated with banks or trust corporations.

Those that dont have can actually resort to the Board of Trustee setup

where individuals appointed by the employer serves as members of the

Board of Trustees of the retirement fund but this setup may not be very

convenient for small companies whod rather outsource the trusteeship

responsibilities.

How will the insurance products fare under this setup?

7.1. Permanent Plans

This should help permanent plans a lot as the trustee setup would

provide the following tax incentives, subject to the abovementioned

conditions:

contributions used for premium payments would be

considered regular trust fund contributions and hence,

deductibel expenseretirement benefits are not subject to tax

The trust fund should be able to take the role of the Premium

Deposit Fund minus the interest guarantee but possibly higher

earnings.

Still, it is difficult to honestly justify that these plans are better

investments than long-term government securities coupled with

GYRT coverage. In addition, the flexibility that the Trust Fund

component may not be enough to fully support a well-defined

retirement program.


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7.2. Group Universal Plan

This setup would not help GUL plans and may even be

disadvantageous if the trusteeship fee is applied also to the GUL

cash value.

7.3. Deferred Annuity Contracts

This setup should help DA contracts as to the deductibility of

contributions but could also be disadvantageous if the trusteeship

fee is applied to the outstanding balance under the contract.

7.4. Group Variable Life Plan

As earlier mentioned, exemption from taxes on earnings may be

achieved by creating a distinct fund for tax-qualified plans. This

fund would have to be under trust.

8. Summary

Recent developments are favorable towards the early setting up of

retirement programs and are also favorable to life insurance companiesAre these enough though?

The answer depends on how insurers could manage the administrative

costs and profit margins that are passed on to the clients, maximize

the value of the strengths they have versus banks and trust corporations

or ride on the strengths of these competitors, and provide better quality

of service.

Bringing down insurer costs begins with knowing the right products, the

right distribution channel and the right market.

Permanent plans that are basically grouped individual plans are not theright products. The other insurance products could be the right products

for certain segments of the market especially it these products

weaknesses are managed.

In general, insured plans may appeal to small companies who should

benefit from the pooling of funds, who may put greater value on a single-

benefits-provider setup as well as guarantees, and who may be looking

for reputable financial institutions that will accept low initial contribution

Guarantees should also appeal to ultra-conservative clients.

Insured plans could support DC programs very well. While basic

retirement programs are of the DB type, there could be a market for

supplementary DC programs if administrative fees become more

affordable.

Distribution through agency or current agency compensation may need

to be revisited. Their value to the client under these programs should be

assessed. Of course, this is easier said than done.

Profit objectives need to be re-evaluated. At a glance, we may be

looking at very slim margins if insured plans are to compete with

trusteed plans. Possible increase in sales of the other products

supporting other employee benefit programs (like GYRT) may be

considered.


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Still, there are a lot of unanswered questions specially for the

group variable products: how regulations would shape up, whether

the variable life fund can really be tax-qualified or not, among

others. Life insurance companies need a few more important steps

towards finding answers to these questions.

Actuarial Exponents, Inc.

Actuaries & Employee Benefits Consultants

Copyright(C) 2009-2012, Actuarial Exponents Inc.,

All Rights Reserved

9/F Unit B & C Strata 100 Bldg., F. Ortigas Jr. Ave.

Ortigas Center

Pasig City, 1760 Philippines

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Are There Opportunities for Insurers in the Retirement Market

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