A new product by Sygnia is set to squash the life annuity versus living annuity debate in South Africa. Soon you’ll be able to get the best of both worlds in one.
A new product by Sygnia is set to squash the life annuity versus living annuity debate in South Africa. Soon you’ll be able to get the best of both worlds in one.
In what may well be the biggest shake-up of the retirement planning sector in South Africa this year, market disruptor Sygnia is launching a hybrid living annuity. It’s going to be low-fee game-changer that can give you a set income and capital to invest.
At retirement, you’re faced with two choices on how to use your retirement savings: choose a life insurance annuity and be guaranteed an income for the rest of your life, or go with a living annuity that gives you more control over and access to your capital, and the ability to grow your capital through investing in the markets.
Those are the pros – the cons make the decision even more fraught. A life annuity doesn’t allow you access to capital in case you really need it, and if you die earlier than expected, the insurance company – not your kids – keeps your retirement savings (unless you’ve opted for a portion of your income to continue being paid to your spouse). With a living annuity you run the very real risk of running out of money before you die and becoming a burden on your nearest and dearest.
It’s a “damned if you do, damned if you don’t” scenario. That’s essentially the conclusion Sygnia’s portfolio manager John Anderson came to along with colleague Steven Empedocles when they penned a paper on the current state of the retirement industry in South Africa.
The paper won two awards at the Actuarial Society of South Africa’s 2016 Convention (the RGA prizes for Best Paper and Best Paper by First-time Authors), but that wasn’t the most important result for the actuary whose spent 16 years of his career in the retirement fund industry. “We knew it anecdotally already, but the paper really brought home how the retirement funding industry has shifted over the past 15 to 20 years towards living annuities instead of life annuities, and how this shift is resulting in more people running out of money in retirement. It means we all have a major problem coming down the line.”
Sygnia ForLife, the new product which launches on March 1, was his response to the crisis-in-the-making facing South Africa’s retirement industry. The first of its kind in South Africa, Anderson’s hybrid product combines the benefits of both a living and a life annuity: guaranteed income for life and capital to invest and access for emergencies.
Essentially it introduces a new unitised asset class that pays an income for life, which can be used together with other traditional asset classes such as equities, bonds and cash within a living annuity. This asset class has very unique properties, especially if combined with other investments.
The annuity puzzle
To understand why a product like this may turn the current retirement market on its head, one needs to take a few steps back and understand why living annuities have overtaken life annuities as the retirement product of choice for South Africans.
Anderson’s award-winning actuarial paper notes that a survey conducted by Just Retirement South Africa in 2016 and The 2015 Sanlam Benchmark Survey both showed that the overwhelming majority of South Africans (86% and 87% respectively) between the ages of 55 and 85 preferred guaranteed income for life in retirement. Yet, statistics from the Association for Savings & Investment SA (Asisa) show that 90% of 2015 retirement annuity sales in South Africa were living annuities – products that do not guarantee an income for life.
This paradox is known as “the annuity puzzle”, and it’s not too hard to fit together the pieces. Straight-talking Anderson puts it down to two core changes in the retirement funding industry over the past 15-20 years:
Companies wanted to downscale their risk of carrying pensions for life so they switched from the old defined benefit arrangements to defined contributions. “This is good in that you get ownership over a pot of money at retirement, but it basically passes all the risk onto people who are now faced with having to make complex financial decisions that they are not always equipped to make,” he explains.
Around the same time, living annuities were invented by the asset management industry, whose overall goal is to grow assets. This resulted in a huge push to sell living annuities from the 1990s onwards. They’ve been very successful: in 2015, R54 billion of new living annuities in South Africa were sold to retirees, according to Asisa.
All of this adds up to one critical point: “The truth is that the retirement fund industry in South Africa has become more geared and structured towards providing an individual the most optimal living annuity investment rather than the most optimal overall strategy,” says Anderson. “This may often not be what’s best for the individual, as it puts investment ahead of sustainability.”
Spotting the gap
It was at this point in his research that Anderson saw the opportunity to create a product that could change the status quo. “You can summarise what you need for the best retirement plan in two goals: the first is providing a sustainable income, the second is providing for flexibility of capital and bequests,” he says.
Sygnia ForLife is able to offer these benefits in one product because it’s a living annuity that includes a lifetime income fund as a unitised asset class within the overall investment portfolio. “By introducing the lifetime income fund as a specific unitised asset class, which pays an income while you are alive, one essentially enables advisers to holistically review a client’s circumstances and within one product trade-off and balance between the two competing goals in retirement.”
And it works for any retirement portfolio, big or small. It’s only the percentage allocation between the traditional asset classes and the lifetime income fund that will differ for each, and this is worked out for each individual using a proprietary Sygnia tool provided to advisers.
“You can choose to have any percentage of your portfolio, from 0% to 100%, invested in the lifetime income asset class, which provides an income for life and the income depends on the performance of the Skeleton Balanced 70 portfolio,” Anderson points out.
“Say your total retirement savings amounts to R1 million and, like most people, you have invested fully in a living annuity that offers no longevity protection. There’s a very real risk of running out before you die. In fact, our tests show most living annuities will only meet 70% of the average person’s lifetime spending needs. Now, if the same person invested 50% of their retirement portfolio in the lifetime income asset class and the other 50% in traditional asset classes such as equities, bonds, cash more than 90% of their lifetime spending needs should be met. The proportions will, however, depend on individual circumstances and goals.”
Less fees, more cash
Then there’s the all-important issue of saving fees; something that can make the difference between a comfortable retirement and living the rest of your days dependent on your kids.
Living annuities are generally high cost – most traditional providers charge anything between 2% and 3% per annum in product fees (administration and investment) alone, and that’s not counting performance fees many fund managers charge. Sygnia’s product fee starts at just 0.4% per annum for its Skeleton Balanced index tracking funds.
“If your current management and administration fees are 2.5% per annum, that’s an immediate savings of 2.1% per annum, which on a savings of R1 million translates into an additional pension of R1 750 every month, or R21 000 every year,” Anderson calculates. “Multiply that for every R1 million invested and you can see what a massive difference it can make to a person’s day-to-day standard of living.”
The good news for retirees kicking themselves for not choosing a fixed income is that they can still make the switch: “The entry investment for Sygnia ForLife is R100 000, so people who are running out of capital on living annuities are able to convert from what they have left to create more sustainability.”
Breaking new ground
Anderson is momentarily speechless when asked why, if this kind of hybrid product is such an obvious solution, no one in South Africa has done it before.
“That’s a good question,” he laughs. “I felt compelled to write the paper after helping a friend of mine’s mother with her planning. Her money would definitely not have lasted her expected lifetime with only a living annuity and so having something that would combine the benefits of a living and life annuity would have been the way to go. Yet no providers had made such a product available to her.
“I think this is a result of the way the industry has developed over the last 20 or so years, where there’s been this big drive to sell living annuities over life annuities. The two have become competing products, sold by competing sectors (asset managers versus insurance companies).
“Insurance companies, in many cases, also seem to have preferred living annuities because of the lower capital charges and higher overall margins. Where attempts were previously made to combine the benefits of both, this was done using complex structures or partially making use of expensive inflation-linked annuities which are extremely uneconomical for most pensioners. Perhaps this is why there’s never really been a thought to introduce the lifetime income fund as a special asset class alongside other traditional asset classes such as equities, bonds and cash, until now.”