September 2008 Question 2

Explain part 4) the decline in historic annuity rates.

1) what does the annuity rate represent here exactly in this question, and what is the relationship between annuity rates and interest rates?

2) The text says "Annuities now pay out less for a given sum" from bullet point number 13 in the question - this means that annuity rates are higher now? For example a sum of 10000 divided by a higher figure would give less payout, no?

3) lower interest rates have added to this-ok since prices of annuities are higher so they will pay out less than before

4) "historical annuity rates are much higher due to higher interest rates" from bullet point number 14 in the question - I don't get this bit - if we look at the first table given in the question we see that at 3% ax = 20.11 while at 9% ax = 10.55. So doesn't this mean that higher interest rates mean lower annuity rates?

 

Anyone?

 

Annuity rates seems to be used here as amount of annuity (pa) you can buy with £100,000.

I think "annuity rates" could be used as the cost of an annuity as well which is a bit confusing if you don't know the context, and especially as the student note seems to have it the other way.

Higher interest/higher mortality means lower costs of annuity and higher amounts of annuity per £ of lump sum.

I suppose if in doubt, you could stick to what makes sense and leave out the ambiguous jargon, eg annuity rates, from your answer.

 

In the briefing note, in bullet point 14, the student has used annuity rates to mean annuity payments, ie he is saying that in the past, annuity payments from a given lump sum were higher because interest rates were higher and life expectancy was lower. Bullet point 13 is consistent with this, ie annuties now pay less than they used to.

However, the table on the second page gives sample annuity rates, but here the student means ax. The payments would be found by dividing the lump sum by the value of ax.

In the table we can see that the value of ax decreases as interest rates increase, ie the payments increase as interest rates increase.

Once you've worked out what this (helpful?) student is trying to say, you must keep your memo to the new manager nice and simple!