Legacy products are those that are no longer sold but are costly to administer and can offer poor value to customers who may be stuck in them.
I am currently working on an UNSW research project on why lifetime annuities are not being sold. While interviewing a group of experts, the recurring issue of legacy products arose, leaving me to think about preventing them.
One must recognise that the guaranteed variable annuity products introduced early last decade where commercial failures and are now legacy products.
There are some suggestions in the Information Note on Innovative Income Streams, but the industry could go further if it agreed on some basic principles of transparency, fairness, transferability, consumer protection and interoperability.
Greater transparency should discourage products that offer poor value for money, and are therefore more likely to be closed in future. Annuity rates for guaranteed products can easily be compared, but less so in the case of newer variable annuities. Some observations and suggestions for improvement are as follows:
- Investment fees are partly transparent. In instances where the provider guarantees an index return but takes the franking and other withholding tax credits, this should be fully disclosed.
- The charges made for administering or guaranteeing longevity credits need to be made clear and comparable. Some products take a percentage of balances as well as guaranteeing the credits. Yet, it is difficult to compare two products where one offers more value in the short run, and the other over a longer time period. Could we not agree to show the present value of the longevity credits at an agreed interest rate?
- Administration charges and payments to intermediaries need to be separately disclosed.
- To ensure that members compare like with like, there should be an industry agreement on investment projection rates.
A second principle is that pricing should be fair. While price transparency goes a long way to achieving this, rating factors depend to a significant extent on market agreements – which are sometimes implicit.
As Guy Thomas has pointed out in his book, Loss Coverage, while it is necessary to avoid competitive anti-selection spirals, it is quite possible for an industry to agree explicitly not to discriminate on grounds such as gender, race or smoking status. We currently have an industry agreement on genetic testing, and similarly there may be grounds for an agreement on discrimination in longevity credits.
Unlike most insurance, where those most in need may have to pay the highest rates, better value life annuities can be given to those with lower incomes and in poorer health. To achieve greater fairness, the industry could collaborate on sharing data.
Whether or not to permit differentiation on gender would likely be a hot topic of debate. Two new products available on the market offer unisex rates, while others do not. Such inconsistency is likely to create problems in future if members, who could have got a better deal elsewhere, turn and seek compensation.
A number of submissions on the CIPR proposals suggested that there should be simple mechanisms for life annuities to be transferred to an alternative provider. Where the initiative comes from the original provider, such mechanisms could include:
- Where guarantees are involved, an actuarial certification that the present values were identical – as effectively required by Part 9 of the Life Insurance Act. The terms of the transfer should take into account the relative financial strength of the transferor and transferee.
- Such certification should also be required to ensure that the present value of expected longevity credits has not changed.
- That death and withdrawal benefits are broadly similar, which may require the issue of a life insurance policy.
- Where the member has investment options, the new suite of options is broadly similar.
- That there is no significant change in the assumed interest rate (AIR), and that any changes to the mortality assumptions do not materially affect payments over the foreseeable future.
An interesting proposal by Martin Hickling is that the members of a longevity pool could be allowed to replace their management company in the same way as members of a managed investment scheme.
This would require support from 75% of members by way of vote. This is not completely unrelated to the suggestion that the trustees of all superannuation funds should be democratically elected, which the Australian Law Reform Commission suggested before the SIS Act was passed.
There is also a need to ensure that products do not cause significant harm to consumers. Two areas that could be addressed include:
- Annuities that do not respond to changes in inflation should not be permitted. Many people do not understand inflation well, and there can be little doubt that bouts of inflation can surprise the unwary.
- While the need to leave bequests to children is overblown, a reversionary benefit may well be required by a spouse. This issue should be explicitly canvassed with spouses before a single-life annuity is offered.
This requires that the data required to administer the product be in – or mapped to – a standardised format. The main purpose here would be to make the information available to financial advice software, but it would also aid in transferability between different providers.
It is possible that ASIC will eventually get around to insisting on something like this list. However, their current approach to facilitating free markets in insurance does not appear promising.
My Paper to ICA2023 proposed a body representative of all stakeholders to take ownership of market rules of this sort. The problem, however, is that many markets are not functioning well because regulators are overly concerned with preventing collaboration, and prefer drafting detailed regulations to enforcing sound principles – such as transparency, fairness and interoperability.
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