A common thread running across the official response to the global financial crisis has been the unprecedented easing in monetary policy. Central banks everywhere have turned the taps on at full blast and are prepared to keep it that way - for as long as it is required, they say.

Short-term interest rates in the top G 7 economies - the US, Euro zone, Japan and the UK - therefore are close to zero while long-term interest rates are just about 2.5/3 per cent. Even in EMEs such as India, the monetary easing has been substantial, though we are not near zero per cent interest rates.

Low interest rates and savings

While they have fashioned an unprecedented monetary policy response for the immediate crisis on hand, central bankers have continued to look to the medium / long term also. That medium term vision is apparent, for instance, in central bankers’ realizing the predicament in which savers’ find themselves now - in an environment of ultra-low interest rates. Very low interest rates can undermine the savings incentive on a prospective basis as well as result in unwanted income volatility for those who are currently living off their savings - the retirees. This problem is quite acute in the G 7 economies given their large retiree populations and has even been articulated in central bank statements.

It is equally or even more relevant in India, but for a slightly different technical reason. India does not have, in relative terms, a large enough retiree population. But given the huge disconnect between the cost of actual living in India and the level of market interest rates (on which are based savers’ regular incomes), very low interest rates can be unsettling for Indian savers too. Indeed, if one notes that the cost of living index (summarized by the consumer price index) has been stubbornly ruling around the 10/11 per cent levels where as market rates such as bank deposit rates are (much) lower, it is clear that this issue is more pertinent for India. In the G 7 economies, market interest rates, by and large, reflect the ground level inflation quite closely. (It is true that bank deposit rates in India have not declined in the past few months as much as policy makers would want, but that does not dilute the general disconnect between the CPI and interest rates on savings products).

Rates volatility and annuities

More generally, going beyond low interest rates, it is interest rates volatility over economic cycles which savers have to really worry about. Variable interest rates can lead to large fluctuations in the level of incomes which accumulated savings can generate. That, in turn, means that savers have to adjust their lifestyles and consumption of goods and services to be in line with their changing income levels. Where such adjustment is not carried out at all or is carried out only partially, it is quite possible that individuals run out of their accumulated savings.

It is here that annuities become relevant. Annuities are a specific type of financial product structured especially as a retirement (financial) planning tool. Life annuities are financial contracts designed to insure against the financial risk created by length-of-life uncertainty by allowing an individual to exchange a lump-sum of wealth for an income stream that is guaranteed to last for the rest of the annuitant’s life.

What an annuity does is to provide income certainty for as long as the saver lives. In simple annuity contracts, nominal income flow is guaranteed, whereas in more complex products, insurance companies can also guarantee inflation-adjusted (real) income flows for the annuitant.

The saver (retiree) cannot outlive his accumulated savings. Also importantly, the insurance element (the mortality credit or premium) in an annuity contract means that an annuitant can expect to earn a higher rate of return on his annuitized savings (wealth) than on his non-annuitized savings. The generation of a mortality premium, of course, depends on the annuitant sacrificing any bequest motive he may have. Product innovations, though, can integrate a certain level of bequests with a mortality premium.

Appropriate time to highlight annuities
The stock market crash of 2008 and the drag on business growth witnessed in 2008-09 were another dimension to the overall financial markets volatility of the past 18 months.

It is in uncertain and volatile times like the present that the stability and certainty features of an annuity product can be better appreciated. The present, therefore, would appear an appropriate time for insurance companies to highlight annuities in their new business initatives.