The search for the perfect annuity – a reasonably priced, flexible source of an income stream lasting the customer until death – has become the Holy Grail of the post-retirement product industry. CATHERINE JAMES checks the progress of those on the quest to find it.
A visiting Russell Group actuary from the USA, Don Ezra, recently noted that whoever succeeds in having the product with the best solution for funding baby boomers’ long and uncertain retirement years will truly “nail” the market. The manufacturers know this, and as ever are racing to develop the ideal product. But what about the superannuation funds?
In this race, an assumption that account-based pensions rule will likely leave a super fund last – despite the current popularity of the pension making it seem a winner. Recent market turmoil, along with the ‘problem’ of longevity, has placed a question mark over the humble pension, tax-free as it is.
Russell’s Ezra faced a bias towards pensions when he addressed a recent forum of the Fund Executives Association on this topic of funding longevity. After outlining the extent of longevity risk, he went on to suggest lifetime annuities had a strong case to be the underlying instrument to deal with this “risk”, albeit with a tweak or two to make them more attractive.
But the Australian fund executives were not easily convinced. As one chief asked: who would champion such a product after legislation had so clearly rendered them second to pensions by a long stretch? Furthermore, annuities were not an easy sell given the inflexible, non-transferable nature of the upfront capital payment for the annuity – an insurance-like contract that guarantees an income for life in exchange for an initial large capital downpayment – compared to pension assets which always remain one’s own, and in one’s control.
The Australian lifetime annuity market lost much of its relevance to the consumer, giving way to the account-based pension, when the asset test exemption for complying pensions and annuities was removed by new legislation last September. The exemption had excluded 50 per cent of assets in either lifetime annuities, life expectancy-based or term-allocated income streams from the asset test. Now they are 100 per cent included. (The trade-off for removing this exemption was to raise the level of the asset test, allowing more people to qualify for the pension, and also increasing the pension amount people could access.)
With the Centrelink benefits gone, many lifetime or immediate annuity providers have responded by closing their funds to new business, suspecting that the demand would dry up. According to Morningstar tables, there are some 135 immediate annuity products on the market. Only 17 of these are still open, and eight of them have less than $5 million in assets under management. “The market [for annuities] has fallen away,” Axa’s life office head of product Elizabeth Foley says. But in its place, Axa, like many others is seeking to offer “other retirement products which are more flexible [than annuities] and better suited to people’s needs”.
Since closing its lifetime annuity to new money last September, Axa felt the decision has been vindicated as last year’s December quarter proved to be the slowest annuity sales quarter on record since 1994, according to Foley. Another manufacturer, Challenger, also closed its lifetime annuity but continues to believe annuities have more of a future than Australians may credit them for. Only a few weeks ago Challenger’s head of technical services, Alex Denham, issued a press release – hopeful it would reach financial adviser ears – demonstrating how an annuity is “an ideal strategy” to protect retirees from rising deeming rates.
Denham later told Investment & Technology how annuities could also defend a retiree’s investment portfolio from the vagaries of a volatile or bear market. “There’s definitely an argument to have an annuity alongside the allocated pension in the current environment,” Denham says. “Allocated pensions would be needing to sell down assets to maintain income at the moment even though selling at this point in the cycle is not advisable. If they were to buy an annuity, they could pay it into the super fund and use that as income to fund their pension [thereby protecting the investment capital].”
While Russell’s Don Ezra seemed to favour annuities among his ideal “decumulation” strategies, he made it clear to the fund executives that he did not hold the answer of what product would be the winner. But he did flag a few possibilities as food for thought.
One idea was an annuity forward contract, whereby a person pays up-front a fraction of what would be required for a regular lifetime annuity, on the grounds they can only access the income from a certain age many years after the payment date.
Another idea was a pooled “longevity” trust, whereby all investors buy units in a trust that provides an income for life but when they die their remaining capital is distributed to the capital investment of those still alive. Suncorp-owned Asteron already released a similar product with elements of both these ideas two years ago, hailing it as an Australian first at the time. It appears to still be the case. The Asteron Longevity Income Stream (ALIS) “is designed to provide income to investors that increases the longer they live”, according to Asteron technical services manager Leila Moores.
Basically, ALIS takes a small portion of the super account at retirement and invests it for 15 to 30 years during the “establishment phase” in an investment of the investors’ choice. Between the ages of 80 to 85 the account switches to the “income phase”. If the investor dies before the income phase kicks in, around 25 per cent of their investment goes to their estate and the balance is distributed to top up the other ALIS investors accounts – called a “longevity boost”. When the person dies in the income phase, the capital is distributed as a longevity boost. “The whole mission of this product is to give people certainty in their retirement,” Moores says.
She adds the fact the investor can’t withdraw a portion of their super until they’re 80 is a positive thing that “gives them certainty in their later years”. She also underlines that the product is more attractive to those with longevity in the genes. But product innovation has really only just begun. The US has already seen a variety of managers develop new products addressing retirees’ concern that their personal finances can last the distance.
A US-based Vanguard actuary was recently in Australia spruiking the next generation of retirement products yet to be released here by the index manager, described as a hybrid product of annuity and account-based pension. Vanguard’s Australian head of retail, Robin Bowerman, says at its simplest the product is a market-linked pension with an insurance wrap. “It guarantees a reasonable amount of money for life, so it has the security of an annuity, but it has the flexibility, allowing access to your funds, that a normal [pension] fund would give you,” he says.
Bowerman admits the big issue with such a product is cost. Theoretically, its pricing could prove difficult for some investors to understand as it is difficult to value a guaranteed income, and the product would necessarily be more expensive than a simple account-based pension. Fund trustees should be concerned with how their members decumulate, Bowerman says, and providing access to sensible education and financial plans was part of a trustee’s role. “Financial advisers are going to play a critical role [in addressing longevity risk],” he says.