We decided to take up this subject on account of discussions with the Life Insurance Association of Taiwan, in which we learned that the Taiwanese life insurance industry started to market individual annuities quite recently. Japan has a longer history of handling individual annuity products. (Fig. 1) Let me outline our experiences and how we look at this particular line of business today.

　In recent years, the rapid aging of the Japanese population has become increasingly evident and it is developing into a serious social problem. It is often argued that the two major causes of the aging population are the improved mortality rate and the decrease in the birth rate. As we analyze these factors more carefully, we note that the decrease in the birth rate is, in fact, the main cause. If we cannot do anything to improve this situation, the shortage of births will continue to be the most serious social problem facing Japan over the coming decades. As people realize the consequences of an aging population, the matter of planning for life after retirement has developed into a matter of great concern. Naturally, one of the most important financial measures that support people's lives in old age is the pension plan. In the United States or in advanced European countries, the three pension systems are often referred to as the legs of a tripod supporting life after retirement. As shown in the illustration on page one, these three legs are made up of public pensions, private corporate pensions and individual annuities. Fortunately, all of these three elements are available in Japan today.

　Looking at a company employee as an example, that employee is covered by what we call the "Welfare Pension Scheme," which is a compulsory public social pension scheme. In this scheme, the employer and the employee share the contribution.

　Then, we have private corporate pension plans. These plans are not compulsory but almost all large corporations and many middle and small corporations have some form of group pension plan. If the plan is designed to qualify with certain legal requirements, the premiums paid by the employer are tax deductible under the corporate tax law.

　Lastly, there are individual annuity products. Any individual is able to purchase an individual annuity policy from a life insurance company on a voluntary basis and to pay premiums to prepare for old age. A premium paid on an individual annuity policy is tax deductible for income tax purposes under a certain limit. The deductible amount is illustrated in the chart shown in the attached material. (Fig. 2)

　At this point let me briefly explain the outline of a typical individual annuity product. Please refer to the illustration in the attached material.(Fig. 3) In this product, premium is payable annually up to age 60, which is the normal retirement age in Japan. If a policy is taken out at age 35, premiums must be paid for 25 years. The curve shown indicates the amount of reserve accumulated under the plan. In the event that the insured dies before reaching 60, the policy guarantees to pay out the total amount of premiums paid to his estate. This illustration assumes that there is a waiting period of 5 years, between age 60 and age 65 before the start of annuity payment. However, it is common to set up a plan without any waiting period. In this case the annuity payment starts as soon as the premium is paid up. The most popular type of annuity payment would be a whole-life annuity with a certain guaranteed period. In the illustration, there is a guaranteed period of 10 years. The annuity is paid whether or not the annuitant is living during this guaranteed period. After this period is over at age 75, the annuity is payable only if the annuitant is surviving. The payment ceases at the time the annuitant dies. One of the attractive features of a life annuity product provided by a life insurance company is the contract which guarantees continued payment of annuities as long as the annuitant is surviving, no matter how old he may be, age 120 or age 150 or even age 200.

　Now, I am going to explain a brief history of individual annuities in the Japanese market. In Japan, individual annuity policies were introduced by life insurance companies in the early part of the 1960s. We had been reading a lot about the development of individual annuities in the United States and in European countries and expected that this product would sell pretty well in the Japanese market. However, the sales results of individual annuities were very poor from the 1960s to the middle of the 1980s. Why? Because the individual annuity products provided by life insurance industry were not very attractive in comparison with the financial products provided by other financial institutions.

　Here, the fact must be noted that this does not mean that the yields realized with individual annuity policies issued by life insurance companies were inferior to the yields available from the products provided by other financial institutions. The reason why products provided by life insurance companies were not that attractive was due to the fact that the interest rate assumed or guaranteed at the time of the contract is set relatively low to provide for a sound and conservative basis, with the payment of excess interest dividends occurring later, as the contract reflects the actual interest income earned by the company. This approach is rational but lacks apparent attractiveness at the time of the contract.

Now as you carefully observe the graph showing the development of individual annuity sales, you will notice that the sales of individual annuities exploded in the middle of the 1980s and that this high level of sales has lasted until the present. (Fig. 4) I wish to give three reasons for this sudden change in the market:

1. While interest rate levels have come down sharply in the financial market, the industry has failed in making timely adjustments of assumed interest rates suitable for life annuities.
2. The Japanese public suddenly began to realize that the aged society was approaching very quickly.
3. Tax deductibility became available in 1984 and the rules were further revised in 1990 in favor of individual annuity buyers.

　If you look at the premiums paid by individuals, about 90% of these premiums cover individual insurance plans, which are basically death-protection-oriented policies, and the remaining 10% are individual annuities that are considered policies to cover protection against survival.

　Now let us review the features to which consumers pay attention at the time of purchasing individual annuities. The fundamental difference between individual annuities and traditional individual insurance policies is the fact that the former is a type of savings products within which the available yield is extremely important. As you are no doubt familiar, what is important with insurance products is how you can obtain a large amount of protection against death with the smallest possible premium. In case of annuities, the question is how you can obtain a large amount of annuities after retirement with the smallest possible contribution. In this sense, people regard annuities as a type of vehicle for savings and tend to compare it with other competing savings plans. In Japan, interest rates began to decline in the middle of the 1980s. Naturally, other competing savings plans had to lower their yields during this period. The life insurance industry was quite slow in adjusting to the change in interest rates. Every time the industry judged it had to lower the assumed interest rates, the reaction came a little too late. In the 1990s, we finally realized that the actual yield we would earn would not cover the assumed interest rates. As you can see, this coincided with the time of the explosion in sales of individual annuities. In short, individual annuities became very popular just as they became quite unprofitable. Hearing this story, it should be clear to you that we cannot recommend that Taiwanese life insurance companies adopt the policy of trying to sell individual annuities by designing the product so that it is unprofitable to the insurer.

　In Japan, a company called Nissan Life was in financial difficulties by the end of the last fiscal year. The relevant authorities decided that this company could no longer continue its regular business. It is said that the main cause of its failure was making a wrong decision in trying to expand the sales of individual annuities, which were too unprofitable at that time.

　I wish to emphasize the fact that one of the most important features of individual annuities is protection against survival. In short, the sales point is this:

"We shall continue the payment of annuities as long as you live no matter how many years or how many hundreds of years it may be."

This is possible only in a life insurance industry where we have actuaries who can handle this type of business

　Lastly, let us discuss the profitability of annuity products. As we have been discussing so far, management must pay close attention to the relationship between what can be earned in investments, and assumed interest rates and the dividend rates reflecting the investment gains.

　Japan made a big mistake in raising the assumed interest rates at the time the market was showing a downward trend of interest rate levels. The second error was that the industry was not quick enough to adjust itself in reviewing the assumed interest rates as the interest rate was going down very sharply. Please study the experience of the Japanese life insurance industry and take it as a model that you should not copy. (Fig. 5)

　Finally, let us discuss the possibility of losses due to the difference between the assumed mortality rates and the mortality rates actually experienced among the annuitants. Looking first at life insurance policies, as you can see, companies would suffer a loss in the case where more insureds die than expected. In life annuities, in contrast, companies would suffer a loss in the case where people live longer than expected. Therefore, Japanese actuaries review and then revise mortality tables for individual annuity underwriting on a regular basis. The mortality table currently used for annuitants is based on a mortality rate for each age obtained by comparing the mortality rate of the 1955 and the 1980 population tables and obtaining the future mortality rate by extrapolation. Mathematically, a uniform annual rate of improvement of mortality rate is assumed. In other words, logarithmic linear extrapolation is used. (Fig, 6) This assumption seems to be quite conservative in taking future improvements of longevity into consideration. However, we should note that experienced mortality among annuitants of life annuity policies tends to show remarkably low death rates. In a country where they have a long history of annuity business as in the United Kingdom, actuaries report on their analysis and point out that experienced mortality of life insurance policyholders is more favorable than mortality of the general population, due to the effect of medical underwriting procedures. Surprisingly, experienced mortality among life annuity recipients is very often more favorable, because those who feel they might not live long do not take out a life annuity policy. It is technically a kind of adverse-selection among insureds. It appears as though annuitants themselves know better about their longevity than doctors! Thus we must remember that analysis of experienced mortality is quite important in managing the life annuity business. However, we must admit that we do not have enough data about our experience since the percentage of annuity business is still quite small and we have very few policies with which we are actually paying annuities. We have yet to continue our studies to be able to statistically construct a reliable mortality table of life annuitants.

　This concludes a brief outline of Japanese individual annuity business. I hope this report may be useful for your future reference.