Jayson Forrest is the managing editor of Money & Life Magazine.
Challenger’s Andrew Lowe identifies the top five trends in annuities and discusses how these trends are impacting financial planners and their clients.
1. Strategies for key retirement risks
The first trend that Challenger’s Head of Technical Services, Andrew Lowe identifies in the annuities market is the development of product and planning strategies for addressing key retirement risks, in particular, the risks of: sequencing, longevity and inflation.
“Planners know their clients can live a potentially long time in retirement and want to know the best ways of making that cash last longer for them. Specifically, how do you make a client’s income last for as long as they do,” Lowe says. “This is a key consideration that planners face every day with their clients.”
This challenge of ensuring that a client’s income lasts for their lifetime, ties in neatly with the different ways planners are using annuities today. But when it comes to lifetime income, Lowe believes annuities are only part of the solution to a broader and more comprehensive approach to retirement income.
“So, irrespective of market volatility, planners can at least partly eliminate the risk associated with long life via annuities, because they can meet a certain level of income that a client might need in retirement. And for a lot of clients, that may be all of their income,” he says.
“We come across many clients who want relatively modest levels of income in retirement. But, they are looking to make sure that if their assets run out, there is a safeguard that kicks in over and above the Age Pension. Certainly, that partial allocation can work quite well to address longevity risk.”
2. Retirement product blending
Lowe says he is also seeing an increasing number of planners blending annuities in with account-based pensions, non-superannuation assets and other retirement assets, to develop more holistic retirement solutions for clients.
“Layering strategies are also applicable for addressing key retirement risks,” he says. “This includes how to integrate different sources of income in retirement, enabling clients to build up their level of income.
“In fact, one way of addressing longevity risk is building a layer of essential income to meet those crucial spending requirements. Effectively, that layer can constitute a variety of income streams in retirement.
“So, some planners will use a layer of Age Pension that a client will either qualify for immediately or at a later point. Another layer might be defined benefit income streams. And if a client doesn’t have access to other guaranteed income sources, then they could use a layer of guaranteed income from an annuity. That’s a layer that planners can build in for their clients.”
Colonial First State (CFS) General Manager, Product and Investments, Peter Chun says CFS recorded an 83 per cent increase in lifetime annuity sales in the last financial year. He says this demonstrates “the growing popularity of ‘income layering strategies’, which combine annuities with account-based pensions and the Age Pension to meet the retirement needs of clients”.
Indeed, with $850 million of annuities already under administration at CFS at the end of July 2017, it has recently included deferred lifetime annuities on both FirstChoice and FirstWrap as part of its range of retirement solutions to protect the financial wellbeing of retirees.
“We are working closely with our partners to grow our product range and now offer deferred lifetime annuities,” Chun says. “We’re expecting to see strong interest from planners in these products as customers begin to take greater consideration of longevity risk.”
Lowe says planners today have a range of products and strategies available to them that will enable them to address the specific income needs of their clients.
“Typically, for the majority of a client’s assets, a planner will apply various forms of ‘retirement income philosophies’ to make sure there is stability of income, and there is a reduced chance of running out of capital. This includes adopting a ‘bucketing’ approach, with the residual assets sitting, for example, in an account-based pension.
“So, these are strategies whereby a planner will allocate an amount to cash, to defensive assets and to growth assets. The planner will then manage the drawdowns out of that total portfolio with a view to reducing market risk for their client.”
Lowe confirms he is seeing a lot of modelling by planners around different combinations of strategies.
“For example, if a client has $800,000 but only $150,000 of this amount is sitting in a lifetime annuity, that leaves $650,000 to invest in a variety of different strategies. And while that presents opportunities for the client to grow their income, planners are also mindful of how much they can afford to withdraw from these investment strategies for their clients.
“So, this concept of safe withdrawal and safe spending rates for clients, and what to sell to make income payments last, are the types of conversations that are very common amongst planners today.”
3. Legislative change
The third trend Lowe identifies is using annuities as a tactical response to legislative change.
“The retirement incomes environment has changed quite a bit for different kinds of income streams over time. So, the use of annuities and other types of income streams has fluctuated in response to legislative change by governments,” he says.
“If you go back pre-2004, there were 100 per cent asset test exempt income streams, then there were 50 per cent asset test exempt income streams. And certainly, legislative changes to the Age Pension assets test from 1 January 2017, has renewed interest in strategies that provide some form of efficient social security interaction.
“For example, something like the doubling of the taper rate, from $1.50 per fortnight per $1,000 of assets reduction in Age Pension to $3.00 per fortnight, has meant there is an appropriate consideration given to strategies that can help with changing the level of assessable assets. In this respect, one of the things that planners have available to them for their clients are lifetime annuities.”
Lowe believes it’s this prospect of continued legislative change that is driving planner interest in different types of retirement products and strategies.
“On 1 January this year, it was the Age Pension assets test, then on 1 July, it was the availability of enhanced income streams. Indeed, there has been a lot of product come to market there, so planners need to continue to watch this space,” he says.
“The availability of products like deferred lifetime annuities and group self-annuitisation arrangements (see below) are going to drive considerable interest in different types of income streams going forward.
“So, tactical response to legislative change and adjusting retirement income strategies in light of legislative change, is a major consideration for retirement income products.”
4. Platform availability
According to Lowe, planners today have much easier access to annuities than was previously the case. He identifies this as being a significant trend in the annuities space.
“The availability of annuities via platforms has been a game-changer in terms of planners being able to access guaranteed retirement income products for their clients.
“Planners have typically had APLs that have allowed them to use guaranteed lifetime income products over the past decade, but the scope of platforms offering them now makes it much easier to blend a part allocation into a lifetime annuity, without planners having to step outside the reporting mechanism and advice tools they are using for clients,” Lowe says.
“So, the availability of annuities via platforms like FirstChoice, FirstWrap and now AMP, and the prospect of more on the horizon, well, that’s game changing for planners in terms of ease of access, ease of implementation and ease of understanding for clients through simplicity of reporting.”
5. Aged care needs and requirements
Lowe believes that while aged care is not entirely within the retirement incomes ‘sweet spot’, it is still an area of significant interest to retirees and their families.
“The major concern of clients about entering aged care, is in fact, the care they receive. Underpinning this is the issue of affordability. So, planners are looking at different ways of structuring a client’s situation to ensure they can afford the sort of aged care they are wanting to receive.”
Lowe says there are a number of different ways and strategies available to planners to help their clients achieve this. This includes the key decision of whether to retain the family home, with other strategies aimed at delivering income for aged care clients.
“And secondly, we see a lot of clients who are very cautious in terms of the investment risk they are prepared to take on. Estate planning and those types of issues also crop up as well. So, there are circumstances where the application of annuities to offset this ‘risk’, do fit into that ‘sweet spot’ for aged care clients.”
Lowe specifically refers to term annuities and an aged care annuity that meets the specific requirements for satisfying the income concerns of aged care clients.
However, he emphasises that affordability remains the key issue for aged care clients.
“There is a significant perception amongst consumers that aged care is very expensive and might be unaffordable. But there are plenty of ways clients can structure their assets to ensure affordability, and that’s where professional advice is absolutely vital for these clients,” Lowe says.
Chun agrees: “In terms of retirement planning, it’s vitally important that clients seek professional advice earlier in the process. And it’s equally as important for planners to ensure that their clients re-engage with them throughout their retirement to review the appropriateness of longevity solutions.”
Deferred lifetime annuities
Deferred lifetime annuities (DLAs) are a form of lifetime annuity where income payments are delayed for a set amount of time. For example, a 65-year-old retiree may purchase a DLA that will provide a steady income stream after the retiree turns 85 and guarantee an income above that of the Age Pension.
DLAs may be attractive to retirees because the commitment of funds for a given income stream declines with the length of deferral. DLAs could be used to complement account-based pensions. Account-based pensions are more income-efficient when drawn down at a faster-than-minimum rate. Drawdowns can be structured so that the balance is exhausted, or close to exhausted, at the time a DLA begins to make payments.
In group self-annuitisation (GSA), participants contribute funds to a pool that is invested in financial assets. Regular payments from the pool are made to surviving members. Pooling mortality risk delivers higher income in retirement than an account-based pension that is drawn down at the minimum rate, while also providing significantly more protection against longevity risk.
GSAs allow pool members to share, but not completely eliminate, longevity risk and do not require capital to back guarantees. They can also be offered on a deferred basis like a DLA.
GSA income is not guaranteed, like annuity income, but it is expected to be higher due to the absence of capital requirements to back guarantees.
Income levels may be lower at older ages if, for example, the entire pool lives longer than expected. Members also lose flexible access to capital and are unable to bequeath residual assets.
Source: Financial System Inquiry, Retirement Income Products.
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