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TRANSCRIPT
Comparing SA annuity
options at retirement
Paper published in the Journal of Economic
and Financial Sciences
(May 2014)
Introduction: Background
• Background to the study
• Most individuals purchase either a life or a
living annuity. This decision is often made
without quantifying the potential benefits
and risks of all the annuity options on offer
(Goemans and Ncube, 2008)
2
Introduction: Goal of study
• To compare various annuity strategies in
order to ascertain which strategy would
have been superior, by looking in the rear
view mirror
• To aid retirees in selecting the most
beneficial annuity strategy/strategies
3
Introduction: Goal of study
• It was established which of various annuity
strategies would have been best to follow
by SA males aged 55, 60 and 65, who
retired in each of the 30 years from 1960 to
1989
4
Introduction: Goal of study
• Present values of the monthly cash flows provided by
47 annuity strategies were calculated in order to ascertain
which strategy provided the largest financial benefits in
present value terms
• Annuity strategies:
– 9 living annuity strategies (3 drawdown strategies combined with 3 asset
allocations);
– 2 life annuity strategies (a level annuity and an annuity increasing by 5%
each year);
– 18 composite annuity strategies (9 living annuity strategies combined with
2 life annuity strategies);
– 18 switching annuity strategies (9 living annuity strategies switched to 2
life annuity strategies)
5
SA literature review
Study by:
• Goemans & Ncube (2008)
• Lodhia & Swanepoel (2012)
6
SA literature review
• Both studies compare various annuity
options available to SA retirees by
employing a forward-looking approach
• In contrast, this study compares various
annuity options historically for a SA retiree
who retired during the period 1960 to 1989
7
Data
• Bond market index data was obtained from
the database compiled by Firer & McLeod
(1999)
• Equity market index data was obtained from
the INet-Bridge database
• CPI data was obtained from StatsSA
• Life annuity rates were provided by Sanlam
8
Methodology
• The discount rate used to
discount cash flows of an
annuity in month n was the
geometric average of the
inflation rates through
months one to n,
as follows:
9
Methodology
• The present values of cash flows were calculated
per R1 million invested
• Male annuitants retired at the beginning of every
year
• Life expectancy determined according to a(55)
life mortality table, as follows:
• Remaining capital at death also discounted to a
present value
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Age 55 60 65
Life expectancy 21 years 18 years 14 years
Methodology: Living annuities
• For living annuity strategies the present
values of cash flows for 810 combinations
were calculated
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Asset class
Risk Profiles Conservative (A) Moderate (B) Aggressive (C)
Equity 25% 50% 75%
Bonds 75% 50% 25%
Age 55 60 65
Initial drawdown rate
5.5% 6.2% 7.3%
Methodology: Living annuities
• Drawdown strategies:
- Maintaining the same drawdown rate (a)
- Adjusting the drawdown rate each year to
increase the Rand amount of income by 5% per
annum (b)
- Adjusting the drawdown rate each year to
increase the Rand amount of income by the annual
inflation rate (c)
12
Methodology: Living annuities
• Costs:
- Underlying base asset management fee including
VAT of 1.4% p.a. on the equity portion of the
portfolio, and 0.9% on the bond portion of the
portfolio
- Annual adviser’s fee including VAT of 0.57% p.a.
- LISP fee of 0.25% p.a.
• Portfolios were rebalanced annually
13
Methodology: Life annuities
• For life annuity strategies the present
values of cash flows for 180 combinations
were calculated
• Two strategies:
- Level annuity
- 5% increasing annuity
• Single life & 10-year guaranteed term
• Initial commission including VAT of 1.71%
14
Methodology: Composite
annuities
• For composite annuity strategies the
present values of cash flows for 1620
combinations were calculated (9 living
annuity strategies combined with 2 life
annuity strategies)
• Life and living annuity strategies combined
on a 50/50 basis
15
Methodology: Switching
annuities
• For switching annuity strategies the present
values of cash flows for 1620 combinations
were calculated (9 living annuity strategies
switched to 2 life annuity strategies)
• Living annuity strategy was switched to a
life annuity strategy 10 years after
retirement
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Results
• Four KPI’s were developed:
– Average rank
– Best rank
– Number of victories
– 20th, 40th, 60th and 80th percentile
– Results (55) (60) (65)
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Results
Using average rank as the determining KPI
• Overall best performers:
Age 55: Liv-C-b-55
Age 60: Liv-C-b-60
Age 65: Liv-C-a-65
• Overall worst performers:
Age 55: Lif-5%-55
Age 60: S(Liv-A-a-60-5%)
Age 65: S(Liv-A-a-65-5%)
• Bar chart results (55) (60) (65)
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Conclusions
• Living annuity strategies are superior to
composite annuity strategies, which in turn
outperform switching annuity strategies
• A retiree would have been worst off had he
invested all of his money in life annuities
• This conclusion is in contrast to the 2 South
African studies
19
Future possibilities for research
• No explicit risk measure used
- Number of times a cash flow payment did
not meet a certain benchmark level, after
which the size of such shortfall could be
determined
• Other discount rates could be pursued
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