RETIREMENT
28 February 2021
KAREN WENTZEL, FIA, FASSA, CFP® Head: Annuities, Sanlam Corporate
Demystifying with-profit annuities
What is a with-profit annuity? A with-profit annuity provides a guaranteed income for life with increases dependent on the performance of the underlying investment. Although the bonus formula depends on market returns, the application of smoothing significantly reduces the effects of market volatility, generating stable returns for investors. Decisions about the increases are partly subjective, as they allow discretion of how to distribute profits from, for example, INVESTORS mortality experience. IN A WITHSuch decisions PROFIT ANNUITY are, however, well regulated and made WANT SOME by experts and INVESTMENT actuaries in the industry. EXPOSURE TO
THE MARKET RETURNS OF A BALANCED FUND
What is a purchase rate? The purchase or discount rate is the net investment return required to provide a level pension. The lower the discount rate, the more it costs to purchase a given initial level of pension, but the higher the expected future increases in pension. Once a bonus has been declared, the purchase rate is deducted from the bonus to determine the increase, e.g. given a declared bonus of 10% and a 3% purchase rate, the pension increase will be 7%.
What is the philosophy for declaring bonuses? The aim with bonus declarations is to declare a bonus as high as possible without jeopardising the financial stability and security of the with-profit annuity portfolio. This will be in line with the stated bonus formula and subject to underlying fund performance and adjustments based on the mortality experience of the pool. What are the risks covered by a with-profit annuity? In a with-profit annuity, the longevity and investment risks of an individual is carried by the insurance company. Pensioners receive a guaranteed monthly income for as long as they are alive. For joint life pensions, the surviving spouse will receive a pension for as long as they are alive, even after the death of the main pensioner. Even if the underlying portfolio returns are negative, your income cannot decrease, although poor returns would limit the increases. Who should invest in a with-profit annuity? Investors in a with-profit annuity want some investment exposure to the market returns of a balanced fund. These investors are willing to take a bit of risk to earn some upside potential, but also seek the security of a guaranteed pension for as long as they live.
Three questions to ask your annuity provider Comparing with-profit annuities from different providers is a difficult and complicated exercise. To help you make a decision, here are three important questions you should ask your with-profit annuity provider before buying an annuity product: 1. Are my funds being placed with a company I can trust to survive for the rest of my life? Get information about the company’s financial stability, the solvency ratio of the insurer and reports by investment analysts. 2. How are the increases calculated? With-profit annuity products designed in the 90s were often referred to as ‘black boxes’ due to the discretion of the providers to determine the increases; despite this, such decisions are made by experts in the field (actuaries). Current product providers should be able to give you details on how increases are calculated, as well as any discretionary adjustments that may apply. 3. What is the long-term track record of the provider and what is the expectation of the level and stability of bonuses? Realistic returns and sustainable and stable increases over the long term should be a feature before opting into a with-profit annuity. Looking at recent increases, and the impact of the economic conditions on future increases, will give an understanding of the sensitivity to market conditions.
With-profit life annuity increases comfortably beat inflation
W
ith the cost of living continually escalating, the ability to secure inflationbeating annual increases on your retirement income is a recurring challenge, especially in a volatile, lowreturn investment environment. Retirement income specialist, Just, has announced 2021 with-profit annuity increases that comfortably beat inflation, benefitting pensioners with a much-needed boost to their retirement income. The StatsSA average year-on-year inflation over the last 12 months is 3.4%, and Just’s with-profit annuity provides its pensioners with an increase of between 4% and 8% in 2021,
depending on the product selection. Since its launch in 2015, Just has focused on enhancing the features, transparency and performance of withprofit annuities in South Africa for the benefit of pensioners and advisers. With-profit life annuities offer retirees an income for life, which will never reduce regardless of what happens to investment markets or how long a retiree lives. An underlying investment component drives the annual increase, and it can be boosted by how astutely an insurer manages its product. “Usually when a pensioner buys an annuity, they expect to earn some investment return and then pay a charge to an insurer for longevity insurance and product management,” says Just SINCE ITS LAUNCH IN 2015, JUST CEO, Deane Moore. HAS FOCUSED ON ENHANCING THE “However, over the past five years, Just has FEATURES, TRANSPARENCY AND effectively paid its own PERFORMANCE OF WITH-PROFIT charges for longevity insurance and product ANNUITIES IN SA
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management, and added around a further 8% in value to clients. This is unique, where an insurer adds net value to asset performance rather than simply levying a charge against it.” The table shows the increases to pensioners on the Just Lifetime Income StableGro product, which is expected to track inflation when investment returns are CPI + 6% after investment management fees. The product has beaten inflation through the value-added product management of Just, even though investment performance has been significantly less than expected. According to Moore, in recent times retirement fund trustees and individual clients have focused on reducing fees to improve long-term value. While admirable, he says it’s even more important to focus on the value-add
after taking account of all fees, which should be disclosed transparently. “With-profit annuities offer peace of mind through their lifetime income guarantees, combined with increases linked to investment market performance. They are available both as standalone life annuities, or as portfolio choices within a living annuity. We believe they are useful as a foundational building block in the retirement portfolio of every retiree,” says Moore.
Deane Moore, CEO, Just
