The trouble with annuities – learning from the UK experience
As Australia’s population ages, and the superannuation system shifts towards
pensions, an increasing amount of attention is being given to optimal retirement
income strategy. Australia has a sophisticated understanding of how to run the
accumulation phase of a defined contribution system, but much less of how to
run the pension phase. There are two key parts to this:
– Retirement income portfolios – CIOs are increasingly of the view that a typical
retirement portfolio for members will be different to the typical accumulation
portfolio. The thinking is generally at an early stage, although income harvesting
strategies are likely to figure more prominently.
– Retirement income products – do we need entirely different products for the
pension phase that address investment and / or longevity risk? The best known
such products are annuities, but there are a range of insured and structured
products which address one or both of these risks.
The level of Interest in annuities as a retirement income solution is not clear.
Although there has been growth in annuity sales in recent years, much appears
to be short term; ie essentially a term deposit substitute. Sales of longer term
annuities have never been a significant proportion of retirement income inflows.
With the Government’s Superannuation Roundtable looking at retirement income
amongst other issues, they might want to read about the UK experience in combining
annuities with defined contribution schemes. A report released this month from the UK
NAPF and Pension Institutes, “Treating DC scheme members fairly in retirement?” is a
great introduction to the practical issues.
At its core, the report argues that annuities are a complex product, and that the typical
member has little hope of choosing the best product for their needs. As a result every year
retirees leave over $1bn on the table in lost lifetime income – 5-10% of the amount invested.
There is little point in getting the accumulation phase right if there is this sort of leakage
at retirement.
Specific problems identified include:
– Asymmetry of information – members are faced with a difficult decision about a complex
retail retirement product, of which they have little understanding, being sold by a party with
much more information than them.
– Access to advice – there is not enough access to advisers with specialist annuity
expertise. Regulatory change (RDR in the UK and FoFA in Australia) is expected to worsen
the issue as advisers retreat upmarket.
– Pricing – a general lack of transparency in annuity pricing, and some evidence of price
manipulation by annuity providers, for example when they know a demand spike is coming.
– Monopolies – where funds appoint a preferred annuity provider, member inertia often
results in poor pricing, and lack of options and innovation.
– Lock-in -unlike the accumulation phase where choices can be changed and mistakes
fixed, members can’t switch or move to correct errors made because of the above issues.
The report is well worth reading for anyone interested in retirement income and can be
found at: