In 2010, as baby boomers across the nation began to transition into retirement, a new reality dawned on financial planners. After 20-odd years of focusing on growth and accumulation, suddenly their pre-retiree clients were heading into a de-accumulation stage of drawing down on their savings. Yet despite rapidly growing interest in secure, consistent forms of income, many believe there's a scarcity of secure retirement income products for retirees to invest in.
There are currently two main styles of guaranteed-income products available in Australia. One form, commonly known as an annuity, is similar to a fixed-interest investment, and can include lifetime, fixed term and fixed term plus residual capital value - in each case this involves the deposit of a lump sum that sits with the product provider, who then makes a series of guaranteed payments until the end of the term of the policy (usually between one and 50 years, unless it's a lifetime annuity, in which case the income stream is guaranteed for life). Westpac, CommInsure and Challenger offer different types of policies in this regard.
The other is guaranteed pensions, which offer a minimum rate of guaranteed return coupled with the opportunity for the lump sum to grow. There are usually annual fees associated with this style of product, but they generally allow more flexibility than other guaranteed-income products like annuities, which can be complex and restrict access to capital for a period of time.
In addition to guaranteed-income products, other fixed-income products, such as corporate bonds, exchange-traded funds and term deposits, can all form a valuable part of retirement investment strategies. Ibbotson head of fixed interest Brad Bugg says that on average, bonds have performed more favourably than equities over the past 10 years.
"It's just that we've been equity-focused in Australia," he explains, a folly that has had devastating long-term consequences for many retirees.
"A lot of retirees have had a significant amount of income erosion in the past few years and their retirement is not looking so favourable as a result."
Australia Ratings chief executive Chris Dalton agrees. Dalton says many people have realised equities are not providing the returns they used to.
"Instead of looking for high-yielding, fully-franked direct shares with a reasonable after-tax return, people are now realising that the marketplace has changed and are assessing the relative merits of debt versus equity," he says.
"There's an increasing awareness that it's obviously more risky to be developing strategies around equity when you're looking to secure capital."
Guaranteed income in retirement
Actuaries Institute chief executive Melinda Howes says guaranteed-income products, such as lifetime annuities, are a crucial part of a retirement investment portfolio because they insure the retiree against longevity risk - the danger of outliving your retirement savings.
"Annuities are life insurance, not death insurance. These products insure you against living. People misunderstand the issue and unfortunately a lot of them hoard their lump sum, holding it aside and living in near poverty because they don't know how long they'll live. At least with an annuity you know there's something coming that can provide some certainty around long-term income. It's a much nicer proposition that offers a better quality of life," Howes says.
Howes authored a paper, "Exploring barriers to Australia's annuities market", that was released by the Actuaries Institute in February. The paper listed four main barriers to the take-up of annuity-style products: a lack of consumer awareness; behavioural factors ("These sorts of 'well I might not need it' products are not so attractive to the consumer," she says); a lack of incentives or compulsion; and legislative and political barriers, which have conspired to stunt the growth of annuities products (see breakout box).
The other barrier is that lower interest rates today mean consumers are paying a lot more for annuities than they were in the 1980s, when high interest rates meant purchasers of annuities could confirm a high level of regular annuity payments for life. Regardless, a paper by the University of New South Wales' Centre for Pensions and Superannuation, "Australia's disappearing market for life annuities" (2008), made a strong case for annuities, in spite of "the large decrease in the money's worth of Australian annuities, and the withdrawal of tax transfer incentives to encourage annuitisation".
BT Financial Group head of retirement, super and investments Rodney Greenhalgh says the annuity market has benefited from an increased appetite for shorter-term fixed-income solutions of about one to three years' duration. But he believes the removal of the assets test exemption on complying income streams severely reduced the market for longer-term annuities, with the result that they now compete on a relatively level playing field with other similar investment solutions.
"We retain a fixed-term annuity because there is a level of demand and there are circumstances where an annuity provides an attractive solution," he says.
"One area where annuities do provide a relatively unique value proposition is in managing longevity risk - we do not currently offer a lifetime annuity and it remains a relatively niche market in Australia - however, this is likely to be an area of growing interest and a potential area where annuity structures provide a new tool in managing retirement portfolios."
The long and short of it
When it comes down to it, guaranteed income is all about hedging your bets when it comes to life expectancy. Challenger chairman of retirement incomes Jeremy Cooper says, that in times gone by, people often retired as young as 60, stretching their savings across the five years until their pension kicked in at 65 - and often died within a few years of reaching 65. Now, he says, the average retiree is potentially facing a 30-year retirement.
Howes agrees, explaining retirees are now grappling with the reality of the cost of their own longevity. She says it's a mistake to simply assume you will live to the median age of 83.7 (for men) and 86.8 (for women), which many retirees do. "They tend to overweight the probability of dying early and underestimate the possibility of living long," she says.
This is one of the behavioural challenges identified by Howes in her recent paper. Another challenge is that people also tend to see the aged pension as a psychological fallback option, when the reality is it's not enough for most people to live on in retirement. She says in the case of lifetime annuities, there's also often a sense of reluctance to invest in a product that might not be needed - if a person does die before their annuity payments commence, their beneficiaries do not necessarily receive the payments in their stead.
Another concern many have with annuity products is counterparty risk - what happens if the guaranteed-income product provider runs into financial trouble and cannot meet its obligations to investors? What if the provider sells its client book to another provider that is not as financially secure? Dalton says issuers of annuities and bonds are tightly regulated by the Australian Prudential Regulation Authority (APRA), which ensures issuers meet criteria for minimum capital requirements, so they can meet their obligations to investors in the event of a financial crisis. "APRA applies very close scrutiny, just as they scrutinise the banks," Dalton says.
"That's one form of protection for investors, but really investors should also look at the risk themselves - does the company have the capital and liquidity required to meet their products? This is particularly important when people are looking for an investment that will run for many years, as opposed to a few months."
Cooper also points to APRA as a source of consumer protection when it comes to annuities. "While I can't say there's zero risk associated with investing in annuities, APRA applies all kinds of theoretical stresses to our products to the point where they say it would take a one in 400-year event to result in risk for the consumer," he says.
AMP director of sales Barry Wyatt says Axa North's Protected Retirement Guarantee pension product levies an annual fee of around 1.5 per cent to 2 per cent, money that is then invested by the company to help cover potential negative returns and enable it to meet the guaranteed-income components of their
investors' portfolios.
"But ultimately, we stand by our product, which is also ASIC and APRA regulated," Wyatt says.
What the future holds
Despite the challenges, the annuities market appears to be making a comeback. According to research undertaken by independent market researcher Plan For Life, annuities sales jumped to almost $2 billion in 2011 - the highest level of annuity sales since 2004, which hit a record $4 billion due to the pending phase-out of an assets-test exemption that was due to occur in 2005.
Plan For Life chief executive Simon Solomon sees the potential for this figure to jump by another $1 billion in the next 12 to 18 months, provided the existing insurers really push their products hard. He says it could even get to $5 billion in annual sales in the next five years if more insurers enter the market. He points out that 10 years ago the relatively large number of annuity providers in the market meant providers could share the burden of consumer education - whereas now there are just three providers to educate the market about the role annuities play in a diversified retirement portfolio.
Cooper is certain the annuities market is growing - pointing to a 74 per cent rise in Challenger's total annuity product sales as proof (according to its half-yearly 2012 results). He says annuities will continue to grow because they offer a stable form of investment that mitigates the uncertainty of equity-based retirement income streams.
"Think about the aged pension - from day one of retirement 70 per cent of retirees are eligible for all or part of the age pension," he says.
"It's adjusted to inflation, provides a fixed amount every fortnight, it's secure - the problem is it's just not enough to live on . an annuity is like a private pension via a life insurance company."
At the same time, he says annuities are not a silver bullet; they're a tool that does a very specific job, providing a bedrock of secure income over and above the pension. "We need to bridge the gap between the pension and a comfortable income, and annuities can help do that," he says.
Industry insiders report that a few non-traditional players are looking to get into the annuities market, which could mean its potential growth could be bigger than expected.
"If that's true, the market could take off. But at the moment, it needs a catalyst - a new player in the market, or an old player back in . but overall, I'm reasonably optimistic there will be some growth and resurgence in this area," Solomon says.
Wyatt says AMP/Axa North will not look to develop annuities. "They're a challenging product when it comes to managing your liability in terms of longevity," he says.
However, the company will definitely develop other retirement income products during the next 10 years,
he says.
"Retirement income products will be one of our industry's biggest growth areas in the next 10 years as the baby boomers move through retirement,"
he says.
Political barriers to retirement product innovation
On 27 January 2012, the Actuaries Institute called on the federal government to remove the large range of barriers to the development of the annuities sector, including:
. Amend the Superannuation Industry (Supervision) Act, that is, modernise the definition of an annuity to allow for product innovation;
. Make lifetime non-commutable annuities exempt from the Centrelink assets test;
. Allow annuities and deferred annuities to be issued as a component of an account-based pension; and
. Ensure non-commutable retirement annuities are exempt from income tax like other retirement products.
On 29 January 2012, the government proposed a superannuation roundtable to examine proposals to expand options in the superannuation drawdown phase, giving hope that impediments to using products like annuities may be removed.
The story in numbers
Despite having one of the biggest pension fund markets, investment in bonds in Australia is just 14 per cent (the world average is 33 per cent) - that's down from 29 per cent in 2000.
Source: Malcolm Maiden, The Sydney Morning Herald, 16 December 2011
The number of annuity providers has shrunk from 12 in 2004 to just three today.
Source: Plan for Life Actuaries
The overall retirement income market has grown at a rate of 34 per cent a year for the past five years (though currently annuities account for just 6 per cent).
Source: Nomura
Australians aged over 60 years hold around $329 billion of the nation's superannuation assets; people aged over 50 years hold around $632 billion - and they're due to transition into retirement in the next 10 years.
Source: APRA
A 60-year-old who retires today has a one in two chance that either they or their spouse will still be alive past the age of 90.
Source: Australian Bureau of Statistics
In 2011, annuities sales jumped to almost $2 billion, the highest level of annuity sales since 2004.
Source: Plan for Life Actuaries
