Studies
Studies 

Are There Opportunities for Insurers in the Retirement Market?

Lyndon F. Fadri, FASP, ASA

(Presented during the 48th Annual 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?

 

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 to premium 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 (as practiced 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 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 of 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 global managers 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 proposal 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

 

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 supplement the 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

 

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) practically shuts 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 and even 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 the following 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 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 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 minimal even 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.

 

 

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 but through 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 unless non-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.   

 

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 Management Fee

 

As mentioned above, trusteeship fee is 0.5% to 1.0% of the fund.  Other than the investment management fee or 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 for 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 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 expense
  • retirement 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.

 

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 companies. Are 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 the right 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.

 

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.