A press release from the Association for Savings and Investment South Africa (ASISA) reports that South Africans had R155.2-billion of their retirement savings invested in some 278 000 living annuities at the end of last year. In 2011 alone these living annuities attracted new inflows of R23.9 billion.
Peter Dempsey, deputy CEO of the Association for Savings and Investment South Africa (ASISA), says this is the first time that the savings and investment industry has been able to release consolidated statistics on the size of South Africa’s living annuity book.
In terms of the ASISA Standard on Living Annuities, which came into effect in 2010, member companies must provide a living annuity status report to ASISA at the end of each year. The first report was due at the end of 2011.
‘All 21 member companies that offer living annuities complied with this requirement, providing us with the first ever statistical overview of living annuities,’ said Dempsey.
The survey makes it possible for ASISA to monitor the level of income drawn by policyholders from their retirement capital as well as the asset composition of living annuity investment portfolios. He says until now the general perception has been that living annuity policyholders generally draw too much income thereby eroding their capital. Another concern has been the potential effect on capital of an inappropriate asset composition in a policy’s underlying investment portfolio. These concerns led Government to reduce the drawdown rate a number of years ago.
By law living annuity policyholders must draw a regular income of between 2.5% and 17.5% of the investment value of the assets if the living annuity policy was bought on or after 21 February 2007. This can be reviewed once a year on the anniversary date of the policy.
The old rules still apply to contracts entered into before then, provided no changes are made to the selected income levels of between 5% and 20% of the value of the assets.
Average drawdown levels
According to Dempsey the survey showed that in monetary terms (the total value of the drawdowns against the total value of the living annuity book) the average income drawdown level in 2011 was 6.99%.
Simply put, says Dempsey, this means that on average policyholders withdrew almost 7% of their capital as an income in 2011. According to Dempsey this is encouraging since the 6.99% average drawdown rate is significantly lower than expected.
‘While we would like to see an average drawdown rate closer to 5%, at around 7% the risk of policyholders’ capital not growing or being completely eroded is much lower than previously thought. Asset managers and economists agree that investors can expect returns of between 5% and 10% in the foreseeable future, which will help protect capital provided drawdown rates remain in the same range and policyholders maintain an appropriate asset composition in their portfolios. But policyholders still need to guard against the risk of eroding capital in real terms should drawdown rates exceed expected returns.’
However, averages do not apply to everyone and there is evidence of smaller fund sizes applying larger percentage drawdowns than bigger portfolios. Dempsey says in cases of inappropriate drawdowns, one of the following scenarios often apply:
- Early retirement due to ill health with the policyholder drawing down a high level of income due to a low life expectancy;
- Older people opting for a high drawdown rate, because of ill health and a low life expectancy;
- People who did not save enough for retirement and who cannot survive on the little income available when a low drawdown rate is selected;
- People who opt for a living annuity with the aim of withdrawing all their capital over a short period of time;
- The beneficiaries of a deceased person withdrawing the capital as quickly as possible.
‘We do believe, however, that the drawdown rate has dropped significantly in recent years, partly due to the adjustment in the legal rate, but also as a result of greater financial adviser intervention. We find that policyholders who are assisted by a financial adviser generally select lower levels of income since they better understand the long-term implications.’
An interesting observation has been that policyholders 75 years or older who are drawing the maximum income rate of between 17.5% and 20% receive a monthly income of only R1 640 (see table below). Dempsey notes that this is only marginally higher than the State old age pension of R1 200 a month.
This highlights the devastating effects of not having saved enough retirement capital.
‘Unfortunately consumers who have not saved enough for their retirement often turn to living annuities for the wrong reason. Being able to draw a higher income from a living annuity than would be available from a traditional compulsory annuity may help someone who does not have enough retirement capital maintain a certain lifestyle in the early years. But hardship will follow when the capital has been depleted over a short period of time.’
The survey produced the following average monthly drawdown versus the average asset value figures:
Prudent asset composition
Since the nature of living annuities dictates that policyholders bear the investment risk and the risk of outliving their capital, ASISA put in place the Standard on Living Annuities, which member companies are expected to adhere to.
Dempsey says the Standard aims to ensure that living annuities are responsibly marketed and administered. In addition ASISA requires member companies to inform policyholders of the risks of drawing too much income. Each ASISA member company is also obliged to make sure that independent financial advisers do the same.
The Standard requires member companies to remind clients and their advisers regularly of the importance of maintaining an investment composition that matches the policyholder’s risk/return expectations.
Dempsey points out that while adhering to prudent investment guidelines within a living annuity is not a legal requirement, policyholders are strongly advised to take them into consideration. The survey shows that only 15.9% of policyholders did not comply with all of the following recommended prudent asset compositions:
- A maximum 75% equity exposure;
- A maximum 25% property exposure;
- A maximum 90% combined equity and property exposure; and
- A maximum 20% exposure to offshore assets.
What is a living annuity?
A living annuity is defined as a special type of compulsory purchase annuity that does not guarantee a regular income. Capital preservation is dependent on the performance of the underlying investments and a reasonable income drawdown level.
Three key factors determine how long the capital will be there to produce a regular income:
- The level of income selected;
- Performance of selected investments;
- The lifespan of the annuitant.