Default regulationsDanie van ZylMarch 2019

Demystifying updated smoothed bonus standards and living annuity criteria

How does it all fit together?

Pension Funds ActDefault regulationsReg. 37 - 40

Default investment portfolio Reg. 37

Can use smoothed bonus portfolio if comply with Standard

Default annuity strategy Reg. 39Can use living annuity if comply with criteria

Why the need for a standard/criteria?

⧁ Both are popular options, but…

Smoothed bonus portfolios

⧁ Perceived as complex and poorly understood

Living annuities

⧁ Member may deplete retirement capital

Smoothed Bonus Portfolios

0.90

1.40

1.90

2.40

2.90

3.40

3.90

4.40

4.90

5.40

Jan-

06M

ay-0

6Se

p-06

Jan-

07M

ay-0

7Se

p-07

Jan-

08M

ay-0

8Se

p-08

Jan-

09M

ay-0

9Se

p-09

Jan-

10M

ay-1

0Se

p-10

Jan-

11M

ay-1

1Se

p-11

Jan-

12M

ay-1

2Se

p-12

Jan-

13M

ay-1

3Se

p-13

Jan-

14M

ay-1

4Se

p-14

Jan-

15M

ay-1

5Se

p-15

Jan-

16M

ay-1

6Se

p-16

Jan-

17M

ay-1

7Se

p-17

Jan-

18M

ay-1

8Se

p-18

Stable Bonus Portfolio Global LMW median

Why so popular…. Resilience!

Smoothed bonus portfolios

Some advisors love them

… others not

Theory

Over a 40 year time horizon – invest aggressively

Practice

Life happensvs.

Is your retirement plan resilient enough to cope?

What can happen to members

Not every member makes it to retirement

⧁ Family get guaranteed benefit – irrespective of market conditions

Retrenchment during economic slowdown

⧁ Members rely on guaranteed benefit to see them through

⧁ Important for blue collar members

Retirement during market crash

⧁ Member receives guaranteed benefit to purchase annuity / lump sum

⧁ Useful in the end stage of a lifestage solution

Standard

FSCA has released an updated draft in November 2018

⧁ Aims to provide additional security to members

⧁ Big improvement on first draft

⧁ Place onus on trustees – appropriateness for members

Sanlam is supportive of the aims of the standard

⧁ Implementation date uncertain

Standard – 2’nd draft

Will allow much less flexibility to insurers

⧁ Bonus formula fixed

⧁ Enhanced disclosure

• Non-vested bonuses

• Shareholder support

• Min & Max funding levels

• Smoothing periods

⧁ Cost disclosure

Standard – 2’nd draft

Will allow much less flexibility to insurers

⧁ Limits tactical asset allocation

⧁ Conditions for changing strategic asset allocation

Potential issue

⧁ During market crash

Commencement date

Past 1 March 2019

⧁ Standard not finalized

⧁ Insurer need to provide information to Trustees

⧁ Trustees need to apply their mind re eligibility

Next steps

⧁ Engaging with FSCA

Living annuities

ASISA Life Insurance statistics

Spot the trend

Living annuities

Most advisors love them

… most actuaries not so much

Theory

An inflation linked annuity is the safest option

Practice

Members want a living annuity

vs.

Despite the risks

Focus on risks

Path dependency / sequence of returns risk⧁ Poor returns upfront reduce likelihood of successful retirement⧁ To maintain real income drawing down many “cheap” units

Reckless conservatism⧁ Too conservatively invested⧁ Need appropriate CPI+ return over 20-30 year horizon⧁ Else income not keeping pace with inflation

Sequencing of returns

R0

R1

R2

R3

R4

R5

R6

R7

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20Years

Sequence

Reverse sequence

C u m u l a t i v e r e t u r n s o v e r 2 0 ye a r s f o r e v e r y R 1 i n v e s t e d

Years

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Sequence 20% 10% 18% 13% 10% 19% 26% 9% 5% 31% 7% 14% 22% -5% -8% -12% 10% 1% -9% -4%

Reversed -4% -9% 1% 10% -12% -8% -5% 22% 14% 7% 31% 5% 9% 26% 19% 10% 13% 18% 10% 20%

article by Glacier

Sequencing of returns

R 1 m l i v i n g a n n u i t y - 6 % i n f l a t i o n ; s t a r t 6 % d r a w d o w n ( i n f l a t i o n e s c a l a t i o n )

Years

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Sequence 20% 10% 18% 13% 10% 19% 26% 9% 5% 31% 7% 14% 22% -5% -8% -12% 10% 1% -9% -4%

Reversed -4% -9% 1% 10% -12% -8% -5% 22% 14% 7% 31% 5% 9% 26% 19% 10% 13% 18% 10% 20%

article by Glacier

R0R200,000R400,000R600,000R800,000

R1,000,000R1,200,000R1,400,000R1,600,000R1,800,000

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20Years

Sequence

Reverse sequence

Criteria

FSCA has released draft criteria in November 2018

⧁ Aims to provide additional security to members

⧁ Stringent drawdown criteria

⧁ Regular measurement of income sustainability

Sanlam is supportive of the aims of the standard

⧁ Concerns with unintended consequences

Stringent drawdown rates

Age Males Females55 4.5% 4.0%60 5.0% 4.5%65 5.5% 5.0%70 5.5% 5.0%75 6.0% 5.5%80 7.0% 6.0%85 8.0% 7.0%

Versus ASISA averages December 2017Average drawdown rate (unweighted) 9.08%Weighted by asset value 6.64%

Impact of maximum drawdown rate

Example retiree A (Male (single), aged 55, R1m retirement capital)

⧁ Max monthly living annuity drawdown R3 750 p.m.

⧁ Inflation linked annuity (guaranteed) R5 094 p.m.

Example retiree B (Male (single), aged 65, R2m retirement capital)

⧁ Max monthly living annuity drawdown R 9 167 p.m.

⧁ Inflation linked annuity (guaranteed) R13 089 p.m.

Impact of maximum drawdown rate

Example retiree C (Male (married), aged 55, R1m retirement capital)

⧁ Max monthly living annuity drawdown R3 750 p.m.

⧁ Inflation linked annuity (guaranteed) R4 241 p.m.

Example retiree D (Male (married), aged 65, R2m retirement capital)

⧁ Max monthly living annuity drawdown R 9 167 p.m.

⧁ Inflation linked annuity (guaranteed) R10 089 p.m.

Use 75% spouse’s pension

Would members rather buy a guaranteed annuity

Yes⧁ Better value for money

⧁ Less risk

No⧁ Bequest motive / poor health

⧁ Need higher starting pension Let’s focus on these members

Unintended consequences

Members with insufficient funds

⧁ Require higher drawdown (despite the risks)

⧁ Look towards retail living annuities. Pay retail fees!!!

Alternative

⧁ Sanlam institutional living annuity / SUF in-fund living annuity

⧁ Cheek-to-cheek with default living annuity

⧁ Same institutional pricing

Bringing it all together

Our experience

⧁ Trustees keen to mitigate risks for default living annuity

⧁ Include a smoothed bonus solution in the mix

⧁ Aim to make members retirement plan more resilient