Solutions to provide “attractive” lifetime group annuities

Drawing on Canadian defined benefit concepts and the experience of one long-standing Australian Church-based defined pension plan, Colin Grenfell believes there is a solution to provide attractive lifetime group annuities.

The government is contemplating that all superannuation trustees should offer a flagship Comprehensive Income Product for Retirement (CIPR) to members at retirement, subject to some limited exceptions. 

CIPR’s will have to provide an income for life, and it is intended that a 100% allocation to an account-based pension alone would not meet the definition of a CIPR. Clearly an immediate annuity component would meet the definition, but worldwide experience is that these are capital intensive and unattractive, especially given the current low-rate environment. 

However, drawing on Canadian defined benefit concepts and the experience of one long-standing Australian Church-based defined pension plan, I believe that there is a solution whereby attractive lifetime group annuities can be provided as set out below.

The features presented below are based on a large superannuation fund and are for illustration only.

The plan sponsor could be a large superannuation fund or a life office and the features can be varied by the plan sponsor. Similarly, the plan sponsor could also be the government or a government agency.

  1. The annuities are payable for life, are non-commutable and the targeted indexation each calendar year is 100% of the CPI for the previous year ending 30 September. Better still, to improve the product, and consistent with the Age Pension, the targeted indexation could be based on the greater of annual increases from the CPI and say AWOTE.

  2. The annuities are purchased by plan members at retirement subject to a minimum age and a minimum purchase amount set by the plan sponsor.

  3. Annuity rates vary by age and sex and are set by the plan sponsor based on the advice of the Plan Actuary (appointed by the plan sponsor). The annuity rates for the first tranche of annuitants (see point #7 below) will apply for at least 12 months.

  4. Fees could be set at product level or tranche level with any variance of expenses, from the fees allowed for in the annuity rates, spread over all product or tranche members via the yearly indexation percentages and reported annually. The plan sponsor would decide the structure.

  5. The plan’s investment policy would be set by the plan sponsor and could be the plan’s current Balanced option. If the plan sponsor is already providing account-based pensions it could be the investment policy (or one of the policies) of the current account-based pensions.

  6. Each year, just before 31 December, the plan sponsor would advise annuitants of the indexation to apply as from the next 1 January, expressed as a percentage of CPI (or AWOTE if applicable) for the previous year ending 30 September.

  7. If the percentage in point #6 above is between 50% and 200%, then annuity purchase rates for the current tranche of business will remain unchanged for a further 12 months. If the percentage in point #6 is not between 50% and 200%, then annuity rates for future annuitants will be changed and a new tranche of annuitants will commence. Reasons why the percentage might be less than 50% would be poor investment performance and/or very low mortality experience. Reasons why the percentage might be greater than 200% would be good investment performance and/or very high mortality experience.

  8. If the percentage in point #6 is less than 25% then the current tranche of annuitants would be given the option of either:

    • Continuing within the current tranche of annuitants and taking the risk of whether the annual indexation percentage might recover to a level above 25% or continue to fall and perhaps even become negative; or

    • Having their equitable share in the fund (as determined by the Plan Actuary and with a constraint that, with the one basis applied to all members, the sum of all shares must equal the realisable fund value at or near the calculation date) transferred to a life office of their choosing and used to purchase a non-commutable lifetime annuity from that office.

  1. Illustrations of the likely distribution of indexation percentages would be provided, using a stochastic investment simulation model, in all marketing material and plan reports. Annual movements in the indexation percentage are minimised by spreading surpluses and deficits, using say the aggregate funding method, over the future lifetime of all annuitants in each tranche, based on next year’s percentage (from point #6) remaining unchanged each year. Robust rules are essential about the treatment of surpluses and deficits. 

  2. The Plan Actuary should advise the plan sponsor about possible adverse consequences from any anti-selection and advise about how to underwrite sub-standard lives.

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Image of David Orford
David Orford says

28 April 2021

Not all lifetime annuities need to be "capital intensive"". It depends on the guarantees that the annuity provides.
Having been actuary to the super fund in question and another Church super fund with similar features, I can say that the system worked well in my time as actuary. There were (from memory) somewhere between 100 and 200 pensioners. Reversionary pensions applied to spouses.
Normally tax prone, high yield assets were allocated to the tax-emempt pension section of each super fund.
Mortality improvements would have occured amongst these long-living clery or ministers, but the affect was imperceptible.

Image of John De Ravin
John De Ravin says

30 April 2021

Colin I wonder whether, in the current very low inflation, low interest rate environment, it might be safer to replace the “25% of CPI to 200% of CPI” range in paragraph 7 with something of the form “CPI less 1% to CPI plus 2%”? (The references to 1% and 2% are just examples). Otherwise you would be constrained to exactly zero annuity indexation in a year when CPI doesn’t change. Also, note that CPI movement can be negative.

Image of Richard Codron
Richard Codron says

30 April 2021

I presume that the purchase will be voluntary which would require conservative mortality assumptions to be used making the terms potentially unattractive for "impaired lives" especially if the annuity is 'single life'. Mortality rate expectations would vary widely across the membership based on socio-economic, ethnic and known health factors etc. Some level of underwriting would assist in making the terms more attractive to the wider community but adds complexity.

"If the percentage in point #6 is not between 50% and 200%, then annuity rates for future annuitants will be changed" I presume that this because the indexation will be depressed/increased relative to the expected mean for the next few years and that the impact of the past investment returns is allocated to the current not future annuitants.

The annuity rates presumably will tend to change each year due to mortality improvement expectations.

Image of Colin Grenfell
Colin Grenfell says

6 May 2021

David, John and Richard - thanks for your responses. They raise a few interesting matters which I will try to collectively elaborate on under four headings:

General: I expect that the dominant influence on the annual percentages will be investment performance and investment volatility not mortality improvements or longevity. I suspect that this is what David was alluding to when he said “the affect [of mortality improvements] was imperceptible”.

Zero CPI changes: I agree with John’s concern about this. The paragraph #7 range could either be altered as John suggested, or alternatively the targeted indexation could be changed to 100% of the greater of (annual increase from CPI and 1% per annum) or to 100% of the greater of (annual increase from CPI, annual increase from AWOTE and 1% per annum).

Underwriting: My #11 refers to this. I agree with Richard that some level of underwriting for “impaired lives” would make the terms more attractive to a wider community but this needs to be balanced against the complexity added.

Tranches: The main reason for the tranches suggested in my #7, is that they would allow the percentages for the following year to be reset to 100% for the new tranche commencing next year. In this way, as Richard indicated, the impact of past investment returns is allocated to the current not future annuitants. However, to avoid unnecessary new tranches and annuity rate changes, my #7 should probably read “… then annuity rates for future annuitants may [not will] be changed”. For example, an unnecessary change could arise if the percentage was just under 50% but was judged likely to increase.

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