Exposure Draft on Pension Products
Pensions are an important component of the social security net. The IRDA expects that as the economy and employment grows, the demand for pensions will also rise. The IRDA had earlier required all pension products to ensure an accumulation at a rate of 4.5% which was also indexed to the Reverse Repo Rate of the RBI. Because of the uncertainty in relation to investment returns etc, that requirement of IRDA did not find wide acceptance in the market. The IRDA has since reviewed the position and proposes to expand the option of pension products.
Pension product, in general, are considered to transfer longevity risk from the individual policyholder to an insurance company. Thus, the insurance company has to value and manage this risk which often only becomes evident after a long period of time. It is evident that the two most important sources of risk for an insurance company in offering the pension products are interest rate risk and longevity risk. Longevity risk arises from deviations between realized future mortality trend and current assumptions. If pensioners on average live longer than projected, insurers have to pay more than expected. with regard to investments, life insurance companies have to invest cautiously for any non profit deferred pension product and immediate annuity products. They have to be even more cautious in the terms offered, because the insurer will almost certainly be exposed to significant interest rate risk and reinvestment risk. There is much more uncertainty in setting the assumptions, considering the long term nature of these products.
While the insurer confronts lot of uncertainty in offering the product, the policyholder, who wish to opt for this product, may also face uncertainty in terms of how much to invest or how much accumulation is required to get a pension which enables him/her to maintain the minimum standards of life. In this case it may be appropriate to educate the policyholder, the premium/ contribution that is required to provide the target benefits or the target benefit that the policyholder might get for the level that the individual intended to pay. Producing both calculations therefore enables the individual to review the target benefit or the intended premium/ contribution, to arrive at the most suitable solution. In order to perform such calculations it may be necessary to make assumptions. In practice, several sets of trial calculations may be required showing the effects of the combination of benefits and different future assumptions. Given the variable nature of many of the elements, instead of detailed calculations it may be often appropriate to make broad allowance for minor items.
Quoting an apparently very accurate premium/ contribution rate or target benefit may also be inappropriate or impossible in most circumstances. What is important and expected in these calculations is to indicate to the prospective policyholder /policyholder the variability of the outcome of future events – a different retirement date or different premium rate can significantly alter the perception of the appropriateness of the proposed product.
In this context, pension products offered by the life insurance companies have a special role to play in promoting and protecting the social policy objectives, such as the provision of retirement income. At the same time there are lots of uncertainties surrounding the pension products. The regulatory framework for pension business of life insurance industry needs to consider this unique characteristic of these products. This has led to the perceived need for greater security in the regulatory approach and the emergence of a strong motivation for the introduction of prudential regulation and supervision due to their critical role as an instrument of social policy.
In this background, all the pension products offered shall comply with the following objectives.
1. A pension product (deferred annuity contract) shall have an assured benefit disclosed at the time of sale, where the assured benefit is an amount in absolute terms which becomes payable on the vesting date.
2. For the purpose of financial planning, any pension product offered by the insurer shall comply with the sales literature guidelines issued by the Life Insurance Council circular number LC/SP/Ver 1.0 dated 3rd February, 2004 and shall also necessarily disclose:
2.1 An illustrative target purchase price for each policyholder considering the premium payment capacity, age, vesting age and the future expected conditions.
2.2 Possible risks involved, if any, in meeting the targeted purchase price.
2.3 Possible risks involved, if any, in purchasing the targeted pension rate/annuity rate.
2.4 An illustrative target annuity/pension rates for the illustrative target purchase price.
3. Any pension product offered by the insurer may have an optional insurance cover throughout the deferment period or may offer riders, which are approved under the file and use procedure.
4. At the date of vesting or at the date of surrender, the policyholder shall be given an option to commute up to a 1/3 rd of the amount realized.
5. At the date of surrender, the balance amount remaining after commutation shall be utilized to purchase pension, guaranteed for life, at the then prevailing annuity /pension rate.
6. At the date of vesting, the balance amount remaining after commutation shall be utilized to purchase pension, guaranteed for life, at the then prevailing annuity rate.
7. The prevailing annuity rate shall mean the annuity rates that shall be allowed to be applied to each of the pension products as per the latest approval accorded by the Authority as per the file and use procedure.
8. If the policyholder dies during the deferment period, the nominee shall be entitled to:
8.1 utilize the entire proceeds of the policy as on that date including the rider benefits, if any, or part thereof for purchasing an annuity at the then prevailing rate; OR
8.2 withdraw the entire proceeds of the policy;
9. At the time of vesting, the annuity shall be provided by the same insurer who contracted the original deferred annuity policy.
10. All the unit linked pension products shall comply with IRDA (Treatment of discontinued linked insurance policies) Regulations 2010.
Note: For the purpose of this circular:
1 For the purpose of illustration:
i. Target purchase price shall mean the accumulated value of the premiums/ contributions accumulating at an illustrative rate of 4% and 6 %, which is expected to meet the policyholder’s pension needs after allowing for commutation.
ii. Targeted pension rate shall mean the pension that a policyholder expects to receive at the date of vesting at an illustrative rate of 4% and 6%.
2 An assured benefit shall mean any guarantee such as any of the following options:
i. Providing a minimum return (non-zero positive return, as per the approval accorded by the Authority) on the premiums paid during the period of contract, which shall be disclosed at the time of purchase of contract;
ii. Providing a guaranteed maturity benefit (in absolute amounts) payable at the vesting date, and which shall be disclosed at the time of purchase of contract;
iii. Purchase a guaranteed annuity from the date of vesting which shall be disclosed at the time of purchase of the deferred annuity contract.