WORDS ON WEALTH
This week I’ll delve a little deeper into life annuities: pensions provided by life assurance companies that guarantee you an income for life. These products offer a surprisingly broad range of options for retirees. With kind input from Nicola Symons, business solutions consultant at Sanlam, we’ll unpack some of them.
Symons says life insurers offer two broad types of life annuity:
1. Conventional annuity:
pension payments may be level, increase at a fixed rate each year or increase at a rate linked to inflation (the Consumer Price Index). The underlying investments are predominantly fixed-interest instruments and inflation-linked bonds, Symons says.
2. With-profit annuity:
the underlying investments may be spread across a range of assets including equities, property and fixed interest. The annuity payments and annual increases are determined by the performance of these assets, Symons says. “Insurers generally smooth out the returns to try to prevent any sharp changes in income from one year to the next. Some insurers may guarantee that the annuity payment will never decrease.”
Conventional and with-profit life annuities have a number of options, such as:
- A guaranteed payment term - the minimum term of the annuity payments.
- Your choice of annual payment increase rate.
- Joint life annuities, which include a spouse or other beneficiary as a second annuitant, who will continue to receive payments after the death of the main annuitant. The annuity amount can be reduced after the first annuitant dies.
All of these options will influence your initial income amount, Symons says.
“You should also consider any capital you may wish to bequeath to heirs,” Symons says.
On its own a life annuity does not provide any capital benefit at death. If there is a requirement for capital at death, Symons says, you can consider:
- Using a portion of your retirement savings to buy a living annuity (the other broad type of pension product, discussed last week); or
- Asking your insurer about a capital protection annuity. “With this arrangement, you will receive a regular income for life and your heirs will receive a lump-sum amount when you die. Your income will be lower, since a portion of your purchase amount will need to pay for life cover. However, this can be more cost-effective than buying life cover separately. There will generally be no medical underwriting on the life cover,” Symons says.
Regarding the protection of your annuity income, Symons says life insurance companies in South Africa are tightly regulated by the Prudential Authority and the Financial Sector Conduct Authority.
“The Financial Soundness Standards (FSS) issued by the Prudential Authority set out prescriptive criteria on the minimum amount of capital an insurance company must hold in addition to the assets it holds to back its policyholder liabilities. This capital must be of ‘sufficient quality and quantity to absorb significant unforeseen losses arising from the risks associated with an insurer’s activities’.
“The FSS also requires that the insurance company must be able to demonstrate that the capital reserve is sufficient to withstand severe market shocks (such as what we have seen in South Africa and across the world as a result of the Covid-19 pandemic).
“This requirement, together with the frequent regulatory reporting insurance companies must provide, is designed to enable the regulator to intervene timeously. This should ensure that action can be taken to protect policyholders long before their benefits would become exposed to the risk of an insurer falling into financial difficulties,” Symons says.
She says that, according to the Association for Savings and Investment South Africa, at the end of last year the life insurance industry held free reserves of more than double what is required by the FSS.