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Four standards to protect pensioners

13 July 2010 Gareth Stokes
Gareth Stokes, FAnews Online Editor

Gareth Stokes, FAnews Online Editor

The saver who reaches old age with enough capital to ‘buy’ a comfortable retirement has yet another obstacle to overcome. They – with the help of a professional financial adviser – must select appropriate financial instruments to provide sufficient income until death. A popular retirement solution is to use the money paid out of a pension fund or retirement annuity to purchase either conventional (level or increasing premium) or living annuities. Conventional annuities pay a monthly premium to the pensioner for life. In this case the insurer carries the full investment risk because they must ensure the capital provides income for life. If the conventional annuity holder dies earlier than expected, the insurer benefits from the remaining capital amount. In the case of a living annuity any capital remaining at death is passed on to the pensioner’s heirs, but the responsibility of ensuring that the capital produces enough income, until death, vests entirely with the pensioner.

The Association for Savings and Investment South Africa (ASISA) has proposed a number of standards to mitigate the risk of pensioners exhausting the capital invested in their investment-linked living annuities, and member companies have three months (until 30 September 2010) to implement the changes necessary to comply. Peter Stephan, senior ASISA policy adviser, says all member companies that market, administer or underwrite living annuities are expected to implement the ASISA Standards on Living Annuities by then. These standards will ensure that living annuities are responsibly marketed and administered by ASISA member offices. FAnews Online takes a quick look at the four standards.

Standard 1: Appropriate drawdown

Living annuities aren’t risk free. One of the major challenges with the product is it allows clients (with assistance from their financial advisers) to stipulate an annual drawdown between 2.5% and 17.5% of total capital. The first ASISA standard deals with establishing appropriate drawdown levels. “Companies must inform all new clients that their financial adviser is obliged to explain to them both the advantages and the risks of a living annuity, and compare these against conventional annuities.” Sensible practice would be for the financial adviser to discuss the appropriateness of the client’s income selection when the annuity is sold, and at least once per year thereafter. The result of this discussion should be reduced to writing.

Although this is probably standard practice among professional financial advisers, ASISA wants clients to understand that the level of income selected is not guaranteed for life! ASISA member companies must do their part too, by informing pensioners that “the level of income selected may be too high and may not be sustainable if they live longer than expected, or if the return on the capital is lower than required to provide a sustainable income for life.” Under this standard ASISA also wants clients to be informed of the possibility of transferring their living annuity from one insurer to another, or converting living annuities to conventional life annuities.

Standard 2: Appropriate investments

ASISA states: “Companies need to remind financial advisers and their clients at the inception of the living annuity and then every year, to assess whether the investments selected in their living annuities are appropriate from a risk / return perspective.” Again we expect professional financial advisers will already be doing this. It remains to be seen whether insurers will offer independent guidance on appropriate levels of risk for return, or perhaps improve their indication of expected returns to aid the client / adviser in long-term planning.

Standard 3: Asset composition

The decision making process required in the first two standards requires knowledge of the asset composition of the living annuity. For this reason the third standard requires companies “to communicate the actual asset composition of the living annuity at the inception of the living annuity and at least annually thereafter.”

Standard 4: Industry-based analysis and monitoring

ASISA has requested its life member companies to furnish it with a living annuity status report at the end of each calendar year. “These individual reports will be made available to the applicable regulatory bodies for scrutiny if requested,” notes ASISA. A consolidated report showing the proportional split of clients categorised by age group and drawdown bands will be made available to contributing offices.

ASISA expects its member companies – those selling the living annuity products – to ensure their financial advisers apply these standards “While the standards set living annuity disclosure requirements, we need to stress that our member companies remain free to determine their own terms of trade like cost, and investment choice,” says Stephan. In this regard financial advisers will do well to assess the impact of living annuity transfers or conversions before advising clients to avail of such options.

Editor’s thoughts: A number of pensioners favour living annuities because of the perceived flexibility in the product. They believe they can increase income by upping the percentage of capital drawdown in times of need. But their expectations are often unrealistic. Are you satisfied with the existing communication between insurer, financial adviser and client where living annuities are concerned? Add your comment below, or send it to gareth@fanews.co.za

Comments

Added by Rene Johnson, 14 Jul 2010
to my mind the biggest problem clients face with living annuities is the letter distributed by the companies at anniversary date of the living annuity. this letter reflects what ASISA in their wisdom recommends the drawdown should be depending on a client's age. BUT none of the companies clarify the fact that the drawdown recommended is specifically related to COMPULSORY Life Annuities which can be bought and not Living Annuities. one thus finds oneself spending endless hours explaining to the client the difference [again] between the two products. in my opinion, and the practice of our company, is to see clients with living annuities at least twice a year - once a year is absolutely not enough. the reduction in yield also needs to be monitored and explained to the client in detail [each time you see them]. comparing the return of the client's investment against that of inflation is vitally important.
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Added by Stikland, 13 Jul 2010
Just a question? Is this not another way from Asisa to control the industry at the cost of the intermediary? Are they going to force you to use a certain composition? Just asking because I am very sceptic about what Asisa suggests wheather it is really in the interest of the clients. Remember their one sidede deal with Treasury to reduce commissions?
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Added by The Financial Coach, 13 Jul 2010
It is all good and well regulating living annuities but it is also time that ASISA outlawed the sale of conventional life annuities where there is no escalation on the income - to my mind, this is as bad (if not worst) than a badly run/managed living annuity. A pensioner who is still receiving the same initial income 15-20 years down the life is certainly not in a good position and is also unfortunately trapped in that position as he/she is locked in for life...at least with a living annuity there is a choice to move elsewhere.
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