For many in the superannuation industry, when they think of annuities, they automatically think of traditional lifetime annuities. Superannuation funds often dismiss this type of product as too costly to offer to members due to the need to protect from investment and longevity risks.
However, this does not have to be the case—these two risks can be “unbundled”.
Unbundled for joy
A lifetime annuity product does not have to provide investment guarantees. Instead, annuities can be unbundled so that an insurer takes on the longevity risk, while the investment management remains the same as that offered by an account-based pension allowing superior investment performance to be passed on to members.
Introducing the investment-linked annuity
One product that unbundles investment risk and longevity risk is an investment-linked annuity. This a retirement income product where investment performance flows through to the member, but longevity risk is insured. Versions of investment-linked annuities have been used in the US for many decades and are now available in Australia, to provide peace of mind in retirement.
Can superior investment performance beat lifetime annuity income?
Effective from 1 July this year, the Retirement Income Covenant requires superannuation fund trustees have a strategy to help their members with the following three objectives:
- maximising their expected retirement income;
- managing expected risks to the sustainability and stability of their expected retirement income; and
- having flexible access to expected funds during retirement
Many funds will rely on an account-based pensions’ superior investment performance to meet those objectives.
However, while investment expertise can add a lot of value to retirement products, using ABPs and good investment performance alone to manage longevity risk will not be sufficient for the best interests of all retired members.
Maximising Retirement Incomes
Optimum Pensions has produced a three-part series with worked examples of a retirement product where investment performance flows through to the member, but longevity risk is insured. We show that good investment strategies, on their own, are not able to maximise retirement income—irrespective of the member’s investment risk profile. The choice of product type is vital.
You can find the series here.