Deferred Annuities - A key part of the retirement planning picture?

It seems self-evident to me that genuine deferred annuities, that is annuities which become payable at quite advanced ages (say 75 to 85), would be very useful tools in retirement planning.

This would allow retirees to guarantee a minimum income level after this age, which would then allow a better managed draw down of capital over their retirement. Currently people either draw down too fast and run out of assets or they are too conservative about using their capital and live an unnecessarily frugal lifestyle in their early retirement years

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Why aren’t deferred annuities available in Australia?

• 1.       Tax – currently the assets backing a deferred annuity are taxed at the 15% superannuation tax rate, rather than the zero rates of pensions and annuities.  This makes the annuity 15% to 20% more expensive to offer than otherwise. 

• 2.       Minimum surrender values – Deferred annuities are being treated as investment products rather than an insurance product and fall under the minimum surrender value requirements of the Life Insurance Act. This means that the deferred annuities can’t really be priced as an insured product at the moment. This makes them expensive. Removing surrender values does make the product riskier from a client point of view, so sales and education processes will need to be well developed in order to minimise the risk of mis-selling.

• 3.       Capital Requirements – The capital requirements for these products are quite stringent. The new capital rules which give benefits for annuities when in the same statutory fund as protection business and also some allowance for illiquidity premiums for the annuities if there is no guaranteed surrender value, may improve this a bit.

• 4.       Mortality improvements – Mortality for over 65 year olds is improving rapidly. This makes pricing these products more difficult. Actuaries have traditionally underestimated mortality improvements, which will make them more cautious in setting future pricing assumptions.

• 5.       A lack of long term fixed interest securities – there are very few really long term fixed interest assets for companies to manage the associated investment risks for providing these policies.

The first two items require the government to change legislation. 

Changing the tax treatment would have minimal revenue implications as none of these products are being sold. The assets that might be used to purchase them would currently be invested in pension products where no tax is payable in any case.

Removing minimum surrender value requirements would be straight forward. As mentioned earlier, some safeguards around sales processes and product disclosure, ensuring that these are treated as insurance products, rather than an investment product.

The government could issue more long dated bonds to allow for better asset liability matching. This would reduce risk and also economic capital requirements by mitigating the reinvestment risk.

The ability of life insurance companies to take a credit for offsetting mortality and longevity risks under the new capital rules may also make these products less capital intensive than they otherwise be.

Deferred annuities should be a key part of the retirement planning menu, but won't be until the required changes are made to the legislative framework.