Blended living annuities deliver higher sustainable incomes

JOHANN SWANEPOEL Product Actuary, Just

In the past the debate has been about which is best – a life annuity or a living annuity? We believe it’s both, and a blend of the two is best. Academic research has largely settled the life versus living annuity debate, proving that a combination provides a more optimal outcome when balancing the competing objectives of having a sustainable income for life and leaving a capital legacy on death. This was also recognised by the FSCA when it granted an exemptionfrom its criteria for living annuities in a default annuity strategy, which paved the way for blended living annuities to be offered as a default option for retirees.

The most common drawcard for choosing a living annuity over a life annuity is the ability to leave a capital legacy to loved ones after death. However, the research revealed a powerful result, which showed that your expected capital legacy at death is higher when you combine a living annuity and a life annuity, compared to a living annuity alone.

Most will find this to be counterintuitive. The simplest way to explain this finding is that the life annuity portfolio can provide a guaranteed level of income at the lowest possible price, which reduces the amount you need to draw from the other living annuity assets each year. This, in turn, leaves a higher balance of the assets on death, compared to if you had just drawn from the living annuity assets alone. Yet, in recent years, over 90% of funds at retirement have flowed into traditional living annuities. Why? There are a few possibilities:

• A lack of understanding in the market of the different risks faced in retirement. The risk of death of a breadwinner, for example, and the financial consequences on a family is easily understood by people. This is why many people buy life insurance to protect the family against this risk and its consequences. However, few people seem to understand longevity risk and its financial consequences, as most people don’t buy life annuities to protect themselves (and their families) from outliving their savings. Some studies have found that retirees fear the risk of running out of money more than they fear death itself, yet they often do not buy the correct product to protect themselves from that risk.

• A lack of understanding of how the different retirement solutions can help mitigate the risks retirees face.

• The costs and remuneration associated with various retirement solutions.

• Regulations that prevent splitting of annuities after retirement.

Empower the many retirees who are at risk of outliving their assets in retirement

Good financial advice from an early age is therefore imperative to help retirees reach retirement with adequate savings and to select the right combination of investment and insurance products to suit their particular circumstances.

In order to adapt to a ‘new’ retirement, it is important for the industry as a whole to challenge convention and drive product innovation to address important gaps left by traditional providers of life and living annuities in South Africa.

The new debate should simply be: What is the best proportion for the blend?

Johann Swanepoel is a Product Actuary at Just and heads the team responsible for Just’s product development in South Africa. He is a qualified actuary with 24 years’ experience. Johann has a notable track record in pension fund valuation, asset liability management and annuity innovation through his work at Alexander Forbes, Sanlam Investment Management and Momentum Employee Benefits. He holds a BCom (Insurance Science) and is a Fellow of the Institute and Faculty of Actuaries (UK) and a Fellow of the Actuarial Society of South Africa.