Retirement incomes II – guaranteed lifetime income

A steady stream of international visitors passes through our office each year on a fact-finding mission to identify potential opportunities in Australia – one of the world’s largest pension markets.  Almost without exception those visitors express surprise that despite leading the world in solving the problem of retirement adequacy, Australia lags so far behind other developed markets in providing options for retiring and retired members.

In particular, compared to our global peers, Australian manufacturers offer far fewer options for a retiree to purchase a lifetime (ie guaranteed) income stream.

And whilst a few years ago the market held a consensus view that annuities were unappealing (too expensive, inflexible, complex), that consensus is shifting.  Takeup of lifetime annuities is increasing (albeit off a very low base) and CBA’s re-entry into that market will provide some welcome competition.

There still hasn’t been much change in how we deal with members’ longevity risk, however – acceptance of product solutions remains very low amongst independent retirement-focused planners; Tria’s recent study of the independent wealth market showed just 10% of those advisers use any type of annuity as a core part of their solution.  Acceptance of variable annuities is even lower, with total assets invested less than $2bn.

In our conversations with advisers and product providers, there is a growing realisation that as balances for members at retirement increase over time, the primary risks faced by those members are changing.  As adequacy becomes less of an issue, the risk of members outliving their savings (despite having a reasonable balance) is rising in relative importance.  There is growing acceptance that the concept of members pooling risk together provides a win/win for customers.

We think the failure of the industry to manufacture and adopt a larger range of retirement income solutions is a function of three things:

• Continuing uncertainty on retirement policy, particularly the timing and direction of any change on deferred annuities. All things being equal a deferred lifetime income option fits well with the challenge of longevity over adequacy (and helpfully it will align to adviser models);
• There is a lack of confidence in the ability of local providers to manufacture guaranteed options (they have far less experience than their global counterparts);
• Third and most importantly, there is a near myopic focus on price rather than value.

 
We’re not advocating that anyone should be comfortable with some of the prices for the now defunct variable annuity offers launched pre-2012. However clearly a solution that transfers risk from the member to an insurer is going to have a cost over and above non-guaranteed solutions.  It is, plain and simple, expensive to offer these solutions. And it is somewhat ironic that we are comfortable with term deposits (even though these implicitly generate margins of 200bp or more) and we are increasingly comfortable with lifetime annuities that have higher margins still.  The difference, of course, is that those margins are hidden in the product construct.
 
Once policy direction is clear we expect to see a range of new guaranteed lifetime income products come to market.  It will be incumbent on product manufacturers to educate advisers on the value being offered by these products, allowing a conversation with members to more accurately weigh the benefits and the costs of longevity protection.  As global leaders in pension accumulation, we need to move quickly to address the gap in providing retirement income solutions.