lifetime annuities a public/private model for sustainable real lifetime additions to retirement...
TRANSCRIPT
Lifetime Annuities
A public/private model for sustainable real lifetime additions to retirement income from superannuation assets.
Financial Demographics
Bruce Gregor FIAA AIA
Disclaimer: Figures show are “ball-park” illustrations and no liability is accepted by Financial Demographics for any use of this material. Information is current only at 18 February 2011
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Purpose of this PresentationThis presentation outlines a Proposed Research Project whichwould be conducted jointly by Financial Demographicsand the Australian School of Business at the University of New South Wales. The purpose of the presentation is to seeksponsorship for this research.
The presentation illustrates a working model of a system proposedby Financial Demographics for provision of lifetime annuitiesfrom part of Australian superannuation assets.
Any figures used are purely “ball-park” indicators. The purposeof the figures is so that people unfamiliar with annuities and reinsurance can readily picture the system to be studied.
The research project will provide actual numbers and conclusionsfrom the latest academic research on mortality pooling and frompopulation projections for Australia and superannuation assets.
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Essential Elements of the Model
“Not for profit” annuity terms Community rating of life expectancy Maintain annuity assets in superfunds Government covers extreme longevity risk Government oversight of risk pooling Standardisation of annuity terms Compulsory 20% in deferred annuity Nil net long term cost to government Investment Guidelines for annuity pools
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“Not-for-Profit” Insurance company rates for annuities have
been shown to include 15-25% loading for selection, longevity risk and profit margin
NFP Super system has substantial scale efficiency which is under-utilised
Insurance company annuity rates are hard to sell compared to high Aust. cash rates
Most people have modest super balances which need to be stretched as far as possible by working on cost margins and efficiency
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“Community Rating” Selection in voluntary insurance makes
annuities more expensive Assumes only long-livers are buying
‘Catch 22’ of current annuity market Rates are not attractive so no one buys If everyone had to buy an annuity, rates
would be more attractive Deferred annuities are very attractive if
community rating applies and NFP
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Illustration – Annuity $pa / $100k
Males$pa
Females$pa
“Select” voluntary insured Immediate Annuity from age 65
$5,000 $4,500
NFP community rated Immediate Annuity from age 65
$6,250 $5,700
NFP community rated Deferred Annuity from age 75
$13,850 $11,600
Main Assumptions: Government Actuary’s Australian Life Table 2005-07with 25 year average longevity improvement. Investment return 5.5%pa,inflation 2.5%pa. “Select” has 20% margin. Purchase price refunded on death (no interest). All annuity figures are current dollars which are assumed to be indexed for CPI inflation after purchase date.
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Maintain assets in current funds A strong fund regulatory structure exits
including provision for segregated pension assets pools
Large funds can leverage current operational efficiency
If full annuitisation existed, post retirement assets would be about 25% of super assets within 20 years
Pooling annuitant mortality in current funds avoids transfer of assets to insurers and saves transaction/intermediation costs (assuming longevity risk can be absorbed by government)
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Government covers extreme longevity
Govt. covers this for public servants Govt. covers this for age pension Insurers “over-reserve” for longevity risk
due to unpredicted future trends and no natural hedge
Nil net cost to government if amount of extreme longevity reserve is balanced by less age pension outgo (if modest income test for deferred annuities) or levy on annuity pools– see Illustration.
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Govt. Oversight of risk pooling Govt. oversight increases confidence of
fund members in annuity rates Pooling reduces unproductive and costly
“competitive” activity Pooling gives more stable annuity rates
averaging over more lives (subject to minimum no. of lives for participant pools)
Government actuary already maintains Life Tables
Future Fund money to incubate a reinsurance co-op company
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Illustration Required Reinsurance reserve for greater than
projected longevity risk (which is in annuity terms) Extreme risk level illustration is 2 x Govt. Actuary 25yr
projection of mortality improvement Equivalent Age Pension Income Test clawback (normal is
50%) to apply to Deferred Annuities: 2.5% if all have 100% age pension 5% if they average 50% age pension due to other
income and assets Alternative is to collect a levy of 1.5%pa of assets from
deferred annuity pools Reinsurance refund to DA pools if Australian population
longevity exceeds projected level in annuity terms Reinsurance company supervises the annual mortality
equalisation transfers between DA pools
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Standardised Annuity terms Lifetime annuities are most efficient when
early deaths release reserves to balance long-livers annuity payments (“communal assets”)
Complex optional annuity terms offer “all things to all people” and reduce the above efficiency / reduce annuity
Pooling works best if annuitant risks are as similar as possible in each fund participating in the pool and the aggregate of all pools equates close to population average mortality
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Compulsory 20% Deferred Annuity
Many Australian’s have little experience with self management of income production from assets during their working life
Financial Planners are not incentivised to spread super money over life expectancy
Advance provision of deferred annuity covers the most fragile stage of life
Population ageing will bring old age voter pressure for age pension rises which could have been funded by super assets
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How the Compulsory DA works
55 60 7065 75
MembersAre educatedOn DA system
Members commit20% of balanceto a DA pool
DeferredAnnuityStarts
1. At age 60 the deferred annuity payment is advised2. This payment is calculated from government actuary tables3. Members are advised a new deferred annuity each year indexed for CPI4. At age 75 the deferred annuity has a further one-off increase if
the member’s selected annuity pool earned more on investment than the real return assumed in the original calculation of standard annuity rates
5. After 75 annuity stays fixed for duration of life except for CPI indexation
Annuity Calculations
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Nil net cost to Government Future Fund invests in new reinsurance
pooling company; on-sell equity to NFP funds when mature – say 10yrs+
Modest income test on deferred annuities or levy on annuity pool to offset extreme longevity risk reserve for deferred annuities
Super funds responsible for annuity admin and keeping track of deaths
Reinsurance claims paid for extreme longevity are balanced by premiums paid
FF return + Cost of established and admin of Reinsurance company covered by sale price
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Investment Guidelines for pools 30% Maximum in listed equity exposure All offshore assets 100% currency hedged Annual cash income from investments to
exceed a set scale % of annuity outgo Inflation linked bonds encouraged Requirement for participating funds to
absorb assets and liabilities of any pools which fall below annuity payment sustainability rules
Governments required to give priority to inflation linked bonds(ILB) when issuing new debt until ILB’s on issue > 50% of deferred annuity pools’ assets
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For more information on this Proposal, please contact:
Bruce Gregor at [email protected]