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Why Guaranteed Annuity Rate policies are a bad idea
By: Milken Institute
August 16, 2012
   
   
Almost two years ago, fresh out of university, I set a goal: to use the skills I acquired through my academic studies for the benefit of the Israeli public.

I joined the Milken Institute Fellows Program and was placed as an intern at the Capital Markets, Insurance and Savings Division at the Israel Ministry of Finance. My first year assignments included conducting research that would assist policy makers in improving the Israeli economy. At the beginning of my internship, I gathered some possible topics for my research and presented them to Prof. Oded Sarig, the head of the division. We talked about different threats to institutional investors and public savings, and when I asked about growing of life spans, Prof. Sarig told me, "this keeps me awake at night."

Increasing life spans and the resulting pension shortfalls are a worldwide problem. Israel, as a young country with more urgent problems, is not as worried about this problem as are European countries and the United States. But the Israel pension market includes a unique product that gives a guaranteed annuity rate (GAR). This means a retiree's monthly stipend would not be reduced if aggregate life spans go up. The problem with this is that the insurance companies that sell this product ("Bituah Menahalim") have been taking a huge risk that could not be properly hedged. I decided to examine how increasing life spans might affect the stability of the Israeli insurance companies.

My research showed that no other country has a product that is as exposed to longevity risk as those sold in Israel. In addition, I ran simulations that showed a small change in longevity would generate a huge loss for the insurance companies. I made two recommendations:

• The government should prohibit products with GAR.
• Insurance companies should add an additional 730 million NIS to their technical provisions to make sure that in all scenarios they would be able to pay their obligations to policy holders.

A few weeks ago, Prof. Sarig agreed with my recommendations and proposed a regulatory change based on them. While the market reaction was quick and sharp (the five biggest insurance companies' equity decreased by 850 million NIS in one day, and "Migdal", the largest insurance company in Israel, lost 10% of its value in just one day), Prof. Sarig continues to agree that these regulatory requirements are truly necessary to prevent a much greater problem in the not-so-long term. The GAR product was a time bomb waiting to go off. It threatened the stability of the insurance companies, and because it represented a quarter of the Israel pension market, the entire Israeli economy.

IaEUR(TM)m grateful I had the opportunity to investigate the GAR issue, and I hope my research findings will help safeguard the Israeli economy.