later years and thus to make it easier for benefit payments to keep pace with inflation; to avoid situations where fluctuations in market rates cause frequent changes in regulated AIRs; and to set guaranteed benefits at a low level.

The first two reasons have some validity, although care should be taken to avoid very low AIRs that cause significant distortions in the time pattern of benefit payments. In this respect, the stipulated zero percent AIR, which was proposed in the stalled Hungarian law of 2009, was probably overly restrictive (Vittas et al 2010). In general, a regulated AIR that is close to the long-term real rate of interest will probably be appropriate for calculating initial benefit payments and will allow sufficient room for future bonuses to cover the need for inflationary adjustments. In most countries, this should be in the range between 2 and 3 percent.

The third reason, concerning the calculation of guaranteed benefits, does not seem to be valid. As shown by the Swedish PPM (see Annex B), guaranteed benefits do not need to be calculated in exactly the same way as initial benefit payments and can be based on a lower rate of interest as well as more conservative mortality tables.

**Mortality Tables.** Specifying the calculation of initial payments also requires the stipulation of the mortality tables that should be used for this purpose. In general, the tables should be based on conservative assumptions with an allowance for future increases in longevity. The same tables should be specified for all providers.<sup>21</sup> Mortality tables should be updated regularly and should be based on the pool of annuitants rather than the general population.

Historically, static period mortality tables, which did not allow for increases in longevity, were used even in advanced countries, while mortality tables were updated infrequently and were suffering from significant time lag. A common practice was to increase the age of policy holders by two years in the case of life insurance and to set it back by two years in the case of life annuities. Developing countries mainly used lagged mortality tables from the United Kingdom and the United States. Over the past two decades, however, insurance companies and pension funds have increasingly started to use dynamic cohort mortality tables that allow for projected improvements in mortality. And a growing number of middle-income countries have started to compile their own sets of mortality tables.

In countries that are members of the European Union, the use of unisex mortality tables is compulsory for pricing purposes, at least for policies linked to occupational benefits. These have potentially adverse effects on different providers and may distort marketing policies. A compensation mechanism may be necessary to transfer reserves among providers. Such a mechanism was proposed in the stalled 2008 Polish law (see section 4.4 below).

**Guaranteed Benefits.** The offer of guaranteed minimum benefits is a customary feature of participating annuities. If the other elements of VPAs are regulated, then the offer of guaranteed benefits should also be subject to regulation. The guaranteed benefits do not have to be equal to the initial benefits. As already noted, while the AIR for the calculation of initial benefits should

> 21 It is interesting to note that even absent such regulation, insurance companies in some high-income countries (e.g. Sweden) have adopted common mortality tables prepared by the association of insurance companies (Palmer 2008). Government regulation, especially if based on expert opinion, would not represent a major departure from current practice.

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