Op-Ed

Hybrid annuities: Some of the choices

By Bruce Cameron 3 June 2020
Caption
A five rand coin is held for display in Johannesburg, South Africa, on Friday, Aug. 20, 2010. (Photo: Nadine Hutton/Bloomberg via Getty Images)

The choice of hybrid annuities is growing all the time. They offer a number of choices combining investment-linked living annuities (living annuity, or illa) with one of the underlying choices being a guaranteed annuity and a with-profit smoothed or stable guaranteed annuity.  

The most favoured combination of a hybrid pension is a with-profit annuity to provide the guaranteed income that should be sustainable for as long as you live. The main difference relates to how future increases on your pension are determined.

With a normal guaranteed annuity, you get as a pension what a life company offers you with future increases specified as either a fixed % increase or as a % of the change in the official inflation rates.

The main features of a with-profit annuity are:

  • Your income is guaranteed for life. This includes your starting income and every annual increase, relating to investment returns.
  •  Annual increases are linked to the smoothed returns of a balanced fund investment portfolio (usually 60-70% invested in equities, with returns smoothed over 5 to 6 years). There may be positive or negative adjustments, usually small, if longevity or credit risk experience is different to the best estimate basis used by the insurer.
  • Your increase can never be less than zero.

While there is a range of options available, many of the legislated pension defaults being put in place by retirement funds are using living annuities, with profit annuities or combinations within the hybrid annuity.

A fair number of asset managers and retirement fund administrators, including the biggest administrator, Alexander Forbes, are using a comparatively new company, Just SA, which specialises in retirement income products with its with-profit annuities as one of the underlying choices for a hybrid living annuity.

In the case of hybrids, many companies are choosing Just SA to provide the with-profit annuity as one of the portfolios within a living annuity.

Other bigger life assurance companies are using their own with-profit structures in combination with living annuities.

The main reason for choosing Just SA seems to be that much of the secrecy has been removed by the company. The increases and investments used by Just SA make use of predetermined formulas and are not wound up in any secrecy.

Some examples:

  • Alexander Forbes head of research John Anderson, says that the Just SA offering is one of the best choices available, particularly with its use of open formulas on how its bonuses (pension increases) are determined. Among other things, he says, the basis of increases for pensioners are more predictable.
  • The Professional Provident Society (PPS), which aims its products at graduated professionals, is using Just SA for the with-profit annuity choice within its normal living annuity as well as its default annuity.
  • Others include Sygnia Asset Managers.

Chief executive of Just SA, Deane Moore, says future increases in your pension are transparently linked to a publicly quoted balanced fund. There may be positive or negative adjustments, usually small, if longevity or credit risk experience is different to Just’s best estimate basis, but every adjustment is audited by an independent company. The cumulative adjustments made to date have been positive.

Moore says before investing a pensioner should talk to a financial adviser, who will tell you about such things as drawdown rates and the annuity rate from Just SA.

Just SA supplies a blending tool which helps out advisers in providing advice on such things as how much to invest in each portfolio, how much will be received by the pensioner and how much may be left to beneficiaries.

Moore says behind the scenes Just SA employs sophisticated risk management to switch between the balanced portfolio and cash/interest-earning assets that will secure your guarantee.

The aim of the company is to keep assets (the capital you invested) and liabilities (what they owe you) in perfect line, regardless of the investment market conditions. Just SA has some of the top actuaries in this field, who have years of experience in developing competitive annuity rates.

Moore says this is significantly better than the early marketing of living annuities, where financial advisers and investors were not appropriately warned of the major problems they would suffer by drawing at an unsustainable level.

Some ad hoc examples:

Alexander Forbes

Alexander Forbes living annuities allows individuals to invest in a range of portfolios provided by various asset managers.  Individuals can also invest in the Just Lifetime Income Portfolio (JuLi), which is a with-profit guaranteed annuity, where the underlying investments are managed in the Alexander Forbes Performer Managed unit trust portfolio which combines a mix of balanced funds from various asset managers.

Actuary John Anderson, who heads research at Alexander Forbes, says that within this arrangement, individuals are able to blend traditional portfolios with a with-profit annuity within a single solution.

“This provides the best of both worlds allowing for the important aspects of the living annuity, with its legacy, income flexibility and market participation; and the with-profit annuity with its income security that ensures your income if you die, even well into the future.

“The combination of the two allows for greater allocation to more aggressive portfolios”.

Anderson says that by combining the two annuities your expected point of ruin, when your pensionable income hits the maximum of 17,5% and then starts to decline in rand terms, will move from 24 years to 28 years. This is based on inflation (6%) plus 3,5% in returns of your investments. On an amount of R5 million invested this would give you an extra R516 427.

The allocation to JuLi can increase over time, which, as you get older, provides a better return.

Sanlam

  • Karen Wentzel, head of annuities at Sanlam says they offer a hybrid or composite annuity, as well as stand-alone living annuities and guaranteed annuities.

For the hybrid annuity:

  • On the guaranteed life annuity side you can choose between a guaranteed escalation annuity, an inflation-linked annuity or a with-profit annuity.
  • On the guaranteed life annuity side you can choose between a guaranteed escalation annuity, an inflation-linked annuity or a with-profit annuity.

Wentzel says for the protection component, the underlying portfolio will provide protection against negative investment markets. The asset allocation strategy aims to achieve returns in excess of inflation plus 3% over periods longer than 3 years. An allocation of 5 times the initial drawdown rate will be held in the Protection Component. This mitigates sequencing risk that is most prevalent at retirement. Sequencing risk is the impact of volatility of investment returns and on the value of the assets. The income (pension) will be paid from the Protection Component.

The market-related component of the living annuity will give pensioners a choice of a moderate aggressive to aggressive portfolios, where the asset allocation strategy aims to achieve returns in excess of inflation plus 5% over the long term.

Short-term market volatility affecting the asset value of the Market-related Component should not be a concern to the pensioner. The reason is that income is not drawn from this component and consequently, the underlying assets will have time to recover following a market crash. A range of single- and multi-manager funds, as well as index tracker funds are available to choose from, Wentzel says.

You need to consult an investment or financial adviser before making any choice about any pension product. For a guaranteed annuity, your decision will be your choice for life, thus you need to take great care and make an informed decision.

Investment advisers can be contacted on the following websites: findanadvisor.co.za; or, for the well-qualified Certified Financial Planner accredited by the Financial Planning Institutes on FPI.co.za; or, the South African Independent Financial Advisers Association, which has a special qualification as a Certified Post-Retirement Practitioner on saifaa.co.za, which among other things has a course for helping pensioners.

Next week: Get a hybrid annuity even cheaper by choosing one from your default annuity. BM/DM

A series of reports written by Bruce Cameron, the semi-retired founding editor of Personal Finance of Independent Newspapers, that cover the effects of Covid-19 on pensioners including research undertaken by Alexander Forbes on retirement income in South Africa. Bruce Cameron is co-author of the best-selling book, The Ultimate Guide to Retirement in South Africa

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