Sanlam has quietly shut up shop on selling with-profit annuities (pensions), which, for many years, have been a major pension choice.
Its main competitors in the multi-billion-rand market, which include Old Mutual and MMI (Momentum/Metropolitan), are still very much in the with-profit annuity business.
Old Mutual dominates the market, with about 80 000 with-profit pensioners and R37 billion in assets under management on its books. The closed Sanlam portfolio has R6.5 billion in assets under management and 16 979 pensioners; and Momentum has about 12 000 with-profit annuity members with about R7 billion invested.
Roy Stephenson, Old Mutual annuities actuary, says Old Mutual is definitely not closing its with-profit pensions to new business. This view is echoed by Momentum.
Liberty closed down its with-profit product for new investments back in 2006, as it did with the Capital Alliance (Norwich life, Fedsure) product when it was taken over from Investec in 2005. The total assets still under management are R3.8 billion.
The closure for new business of the Sanlam product comes at a time:
* National Treasury is looking at a with-profit-type annuity playing a far greater role in the local pension market (see “Treasury looking at a new type of hybrid pension”, below);
* There are stricter new international capital adequacy requirements, which could see life assurance companies having to hold additional reserves to back guarantees, potentially reducing future pension increases for with-profit policyholders (see “What is a with-profit annuity?”, below); and
* Low interest rates are affecting pension increases, because interest-earning assets make up a big portion of the underlying investments.
Treasury wants to see pension providers, such as life assurance companies, sharing risks with pensioners instead of simply having traditional annuities where life companies take all the risks and investment-linked living annuities where the pensioners take all the risks.
Danie van Zyl, head of guaranteed investments at Sanlam Structured Solutions, says that with-profit pensioners who hoped their choice would lead to high increases relative to inflation were starting to question the product.
Pensioners’ concerns included:
* Pension increases were not transparent. The pensioners saw the way Sanlam applied its discretion in determining annual pension increases as a “black box”.
* Many with-profit annuities were sold at relatively high purchase rates when interest rates were high. As increases are only given to the extent that returns exceed the purchase rate, members should expect relatively lower increases when returns are lower.
* Pension increases are not only determined by investment returns, but also by the mortality experience of the assurer’s with-profit annuity book. If members live longer than originally anticipated, this will negatively influence the potential for future increases.
Van Zyl says although Sanlam is closing its existing with-profit annuities to new business, it has added another guaranteed annuity to its annuity stable. He says existing with-profit pensioners can switch to the new product or another type of guaranteed annuity.
The new product is called The Complete Picture Pension, in which Sanlam takes over all the mortality/longevity risks. This means future pension increases will not be affected by pensioners living longer than originally assumed.
Pension increases will still be determined by market returns, but this will be done more transparently, with the increases “derived from published market indices”.
Van Zyl says given the level of guarantees provided, The Complete Picture Pension is considered a guaranteed annuity rather than a with-profit annuity. He gave the assurance that Sanlam will continue to actively manage its existing with-profit portfolio. Pensioners are not being forced to convert to another type of annuity, and Sanlam will continue “to meet the needs of the existing members”.
WHAT IS A WITH-PROFIT ANNUITY?
A with-profit annuity is a mixture of a guaranteed annuity and an investment-linked living annuity.
It is similar to a guaranteed annuity in that you will pay a rand amount for each rand of initial pension. This amount will vary between pension providers and can affect future pension increases, with lower possible increases if the initial pension paid is more than the market average.
It is similar to a living annuity in that the pension increases (annual bonuses) you receive (to counteract inflation) are based on investment market returns. In other words, you bear the risk of future increases: the better the portfolio’s investment returns, the better your increases. Once an increase (bonus) is declared, it is added to your pension for life.
However, a with-profit annuity is unlike a living annuity in that:
* You do not decide on the underlying investments. The asset managers and actuaries employed by the life assurance company to calculate the guarantees do this. The problem for pensioners can be the underlying allocation: the more conservative the underlying investments, the less a life company has to keep in back-up reserves (capital adequacy requirements), but then the expected pension increases will be lower. Conversely, the higher the allocation to equities, the better the potential pension increases, but the higher the value of the reserves the life company must hold, which means potentially lower profits for the company.
* Depending on the guarantee you have chosen, a with-profit annuity dies with you or your surviving spouse. There is no residual payment to your heirs.
With-profit annuities were very popular during the late ’90s and early 2000s, being the main offering when pensions were outsourced by defined-benefit funds that closed down in the move from defined-benefit to defined-contribution funds.
Many pensioners who switched were later disappointed, as they did not understand the pension structure.
The pensions come with what are called initial purchase discount rates. The higher the discount rate, the higher the initial pension, but the lower the future increases. For example, a with-profit pension with an initial purchase discount rate of five percent means that your pension increase equals the investment returns of the year less five percent.
The initial higher pensions provided by using higher discount rates misled many pensioners into agreeing to the outsourcing of their pensions, only to be disappointed by future pension increases.
TREASURY LOOKING AT A NEW TYPE OF HYBRID PENSION
National Treasury in a recent discussion paper recommended greater use of what it termed “variable annuities”, which would allow pensioners and financial services companies to share the risks in providing a pension for life.
Variable annuities, which are similar to with-profit annuities, are a form of insurance policy in which pensioners share risks with a life company, with increases being dependent on the investment returns of the annuity portfolio. The main features are:
* They pay an initial income to pensioners depending on the amount of their premium (retirement savings invested), how long they can expect to live, and the expected investment returns to be earned on assets.
* Pensions are adjusted up, and possibly down, in line with the investment returns and mortality experience of all the pensioners in the portfolio. So if investment returns are good but a lot of pensioners are dying sooner than anticipated, you will receive higher pension increases than when investment returns are poor and fewer pensioners are dying.
* They may pay death benefits to pensioners’ dependants.
* Once bought, you cannot switch out of the product, because it could undermine the guarantees given to other pensioners in the risk pool.
Treasury says a key factor will be how risks for maintaining a sustainable income flow are shared between pensioners and life assurers.
It says it will probably be desirable to have standardised risk-sharing rules to assure a minimum level of mortality protection (income until you die). However, choosing a standardised risk-sharing rule would be difficult, particularly if assurance companies are permitted to compete for business on the open market.
Treasury says there is a moral hazard in that life assurance companies could place too much risk on variable annuity pensioners by:
* Attracting new policyholders by paying existing members unsustainably high incomes on the basis of yet-to-be-earned investment returns, transfers from future members or unreasonable mortality expectations (incorrectly estimating that too many pensioners in the risk pool will die young);
* Exposing pensioners to high long-term investment risk to pay existing members a high income; and
* Failing to process the deaths of policyholders correctly, since pensioners themselves and not the assurance company would be bearing a great deal of the mortality risk.
But Treasury says if variable annuity pensioners bear too little risk, their relative advantages of variable annuities over conventional life annuities begin to fall away.