The topic of retirement reform has become an obsession in the retirement industry over the past few years. Government is seeking to improve the sustainability and effectiveness of the provision of retirement income.
Notwithstanding these differences, there is a clear agreement that the responsibility of retirement funds should extend beyond the savings phase into the provision of income. Funds will need to ensure that members have access to the correct income products and that the options selected are well considered.
Two products can be selected for use with compulsory funds to provide a retirement income. These are a living annuity or a guaranteed annuity. Many funds have considered the implementation of in-fund options to allow members access to cheaper fees and to keep the members with the ambit of the fund and thereby provide greater protection.
Living annuity
It is easily manageable for a fund to provide an in-fund living annuity as the living annuity is a linked policy, and the fund would therefore not be taking on any risks on behalf of the member. The fund would in theory continue to provide administration for the retiree’s funds, with the addition of a payroll function. This route has been taken by multiple defined contribution funds in South Africa.
The challenge here is to ensure that annuitants do not overdraw their living annuities and thereby impair the long term sustainability of their retirement income. Annuitants are able to select an annual income of between 2.5% and 17.5% of their assets. This allows the annuitant, without access to comprehensive and understandable advice, to make decisions that ignore the long-term ramifications of an overdrawn income. A burden therefore exists on trustees to make sure that annuitants receive significant upfront and ongoing financial advice.
Guaranteed annuity
In order for a fund to implement a guaranteed annuity solution, the fund would need to take on certain risks. Unlike a living annuity, a guaranteed annuity entails the provider taking on risk to protect the annuitant. These risks are primarily investment, longevity, inflation and behavioural risk.
Therefore, if a fund opted to provide a guaranteed annuity to retiring members, the fund would take on the liability for those protected risks. In defined benefit funds, this is possible as the fund has a sponsor that would assume the ultimate liability if the priced risks moved in a negative way.
This is not the case in a defined contribution fund where there is no sponsor to pick up the bill should risk events happen. Defined contribution funds are technically unable to provide in-fund guaranteed annuity solutions.
With the introduction of impaired annuities to the South African market, the development hurdle for funds to offer good value guaranteed annuities is further increased.
Lucrative alternatives
However, there are alternate solutions to make sure that members have access to well-priced guaranteed annuities. This could take the form of a default guaranteed annuity selection, where the trustees would select a defined income escalation rate and every member retiring from a fund would receive a quote, from one or more external providers, with the aforementioned option selection. This option requires minimal advice with the maximum chance of a long-term sustainable income.
Alternatively, the fund could provide access to an annuity market that provided the retiree with a range of options from multiple providers. This is the open market option that would require trustees to make a financial adviser available to retirees in order to make a well-considered income selection.
Going forward
The extension of the role of a retirement fund beyond retirement will bring its own unique challenges. However, the South African insurance industry is well positioned to assist trustees to take on these additional requirements to ensure that income is maximised and sustainable.