Annuity innovation no oxymoron
New generation solutions breathe new life into SA retirement industry
While annuity solutions have been the primary source of retirement income for South Africans for decades, they tend to receive criticism for not keeping up with the evolving retirement landscape. Yet the local annuity market has undergone considerable change in recent years to address the increased risks faced by retirees and to cater for their individual needs.
Fundamentally, retirement income products aim to address the major risks in retirement, namely the risk of living longer than expected, the risk of costs rising more than expected and the risk of investment market volatility. In practice, however, people want a cost-effective retirement income product that sets clear benefit expectations and offers flexibility, by not tying them in or restricting them when their circumstances change.
The private retirement investment market in SA is quite progressive compared to other countries like the UK. Our market may be significantly smaller, but it does not stand back when it comes to innovation! And while people tend to place importance on the accumulation phase, innovation in the decumulation phase should not be overlooked. Retirement regulations require you to use at least two-thirds of your retirement fund savings to buy an annuity when you retire, namely a living annuity or a guaranteed life annuity.
While no annuity products score full marks on their ability to address every retirement risk and need effectively, by comparing them individually we are able to get a better sense of how well suited each product is to a retiree’s individual circumstances and risk appetite.
From a risk point of view, a living annuity poses both investment and longevity risk. This is because you ultimately make your own investment decisions and therefore carry your own risk, and there is no protection in place from outliving your savings and investments.
Figure 1: Living Annuity Gauge
Source: Just SA
While there is some inflation protection depending on your risk appetite, this is not guaranteed and generally, the negative impact of market volatility can’t be mitigated.
From a complexity perspective, living annuities appear to be simple products, but the difficulty arises in deciding how much is the right amount to draw in order to balance consumption needs and ensure that your money lasts for your full retirement. Living annuities offer a high degree of flexibility in terms of investment choice and the ability to adjust your annual drawdown within certain parameters. Value for money will also vary depending on the applicable fees.
New Generation With-Profit Life Annuity
A with-profit life annuity offers a lifetime income that will never reduce, no matter how long you live or what happens to investment markets, while providing the ability to still participate in investment markets without the risk of a negative return.
Figure 2: With-Profit Annuity Gauge
Source: Just SA
The term “with-profit” is derived from certain product elements where risks are shared or pooled across policyholders, which reduces the need for additional costly guarantees. With-profit annuities can also offer additional value-enhancing features like minimum payment periods or spouse’s benefits.
With-profit annuities score well in protecting retirees against all three key risks – longevity, inflation, and investment risk. This annuity solution also ranks highly on perceived value for money but does not offer flexibility. In terms of complexity, with-profit annuities are relatively simple as they are clear about the level of income that is guaranteed for life and what percentage of inflation the annual increases target. However, some additional decisions are required around what level of spouse’s income should continue after your death and whether any other financial dependants should be named as beneficiaries.
A blended annuity offers a good solution to the great annuity puzzle: while the vast majority of retirees are invested in living annuities, they paradoxically want income security as a primary requirement.
Figure 3: Blended Annuity Gauge
Source: Just SA
So if it is the perceived lack of flexibility of a life annuity that makes retirees lean towards living annuities, a blended annuity can help to solve this problem by combining the flexibility of standard living annuities with the security of guaranteed life annuities in one optimal product.
With a blended annuity, you get the best of both worlds. By deciding how much should be invested in the guaranteed life annuity component that forms part of the living annuity, you can choose where to position yourself on the risk spectrum between your needs and wants.
The combination of living and life annuity solutions in one product – a blended annuity – results in a product that is highly flexible and mitigates the primary risks in retirement. In overview, looking at the product gauge, blended annuities score highly on all fronts, and are no more complex than any of the other options.
Over the last decade, annuities in South Africa have evolved to address the existing gaps in the traditional retirement market and meet the changing needs of retirees. However, we should not stop there. As an industry we must continue to challenge convention and drive annuity product innovation to help our customers achieve a better later life.
Article by Bjorn Ladewig, Longevity Actuary and Head of Distribution
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