This is the second part of the story 'Right on time'.
Fresh takes on guarantees and growth
The providers of retirement-funding products are adapting rapidly to the new thinking on how to manage retirement assets, and innovative guaranteed and market-linked investment products are continually coming on to the market.
For example, Old Mutual - the biggest player in the guaranteed with-profit retirement product field, with more than R50 billion in retirement assets - has restructured its traditional guaranteed product.
Old Mutual's traditional product provides a full capital guarantee, with returns declared as annual bonuses, all or part of which can be added to the guaranteed capital amount. Any bonus not added to the guarantee is called a non-vesting bonus and can be removed under extreme market conditions.
The investment portfolio is, however, a managed portfolio with money invested in all asset classes.
But the capital guarantees come at a cost, Craig Aitcheson, the head of Old Mutual Actuaries and Consultants (OMAC), says.
For example, a 70-percent capital guarantee can cost 0.75 percent of the amount you have invested every year. For a person who is saving 15 percent of his or her salary over 40 years, the cost of the guarantee can reduce the amount accumulated at retirement by 15 percent.
Aitcheson says although new-generation products can have lower guarantee costs, the cost of a guarantee over your entire working life can still be significant. In volatile markets, a guarantee may prove valuable, but its cost must be weighed up against the benefits.
Aitcheson says OMAC's research shows that historically South African equity markets take 61 months or less to recover from a downturn. A balanced fund will recover its losses far quicker than an equity-dominated fund.
He is adamant that investors need protection against volatile equity markets in the six to 10 years before retirement. But with the traditional product, you were given a full capital guarantee immediately on switching to the guaranteed portfolio, which came with the additional cost.
The new-generation guaranteed products take account of both time from retirement and the cost of the guarantee. The further you are from retirement, the lower the level of the capital guarantee.
The new products balance targeted returns (with the more aggressive high-return, higher-risk portfolios holding more equities) with various capital guarantee levels and different guarantee fees.
For example, with Old Mutual's new Absolute Growth range of portfolios, fund members can:
- Initially, invest in the Absolute Smooth Growth portfolio, which targets growth of CPI plus six percent, with a 50-percent capital guarantee. The cost of the guarantee is 0.2 percent a year of the accumulated value of your retirement savings.
- Six to eight years before retirement, switch to the Absolute Stable Growth portfolio, which targets CPI plus 5.5 percent, with an 80-percent capital guarantee. The cost of the guarantee is 0.7 percent a year of the accumulated value of your retirement savings.
- Two years before retirement, switch to the Absolute Secure Growth portfolio, which targets CPI plus 3.5 percent, with a 100-percent capital guarantee. The cost of the guarantee rises to 2.7 percent a year of the accumulated value of your retirement savings.
De Wet van der Spuy, the head of Old Mutual Corporate's guaranteed investment portfolios, says the advantages of this approach compared with switching between different investment portfolios (such as from a market-linked to a fully guaranteed product) are:
- Lower costs, because there is no need to disinvest and reinvest the underlying assets;
- Simplicity, because the level of protection can be increased at any time and there is no need to facilitate gradual switches over a period of time; and
- Ease of understanding for investors, because the portfolios have the same rules.
He says the timing of a switch into a guaranteed portfolio or between the guaranteed portfolio options will depend on how conservative your target portfolio is and how aggressive your initial investment was. If you invested quite aggressively, you would want to start reducing your risk gradually over six to eight years before you retire.
Discovery Life, a new entrant to the market, has adopted a different approach with its market-linked retirement products, but it is still based on reducing risk tolerance as you get older and near retirement.
Discovery Life has made the process of adjusting the asset mix and risk level seamless by offering underlying unit trust options that have staggered maturity dates, tailored to the year in which you expect to retire. Discovery Life has set up seven Target Retirement Funds, which have targeted retirement dates for every five years from 2010 to 2040.
The funds are managed by Investec Asset Management, and the mix of asset classes in which a fund invests will be adapted by the fund manager as you approach retirement.
Kenny Rabson, the head of product development at Discovery Life, says currently as investors approach retirement they are moved out of equities and into more conservative investments by their brokers or because they are invested in lifestyle portfolios.
This asset change is often made at set dates without taking into account the prevailing market conditions, which may be unfavourable. Rabson says with the Target Retirement Funds a fund manager decides when it is best to adjust the asset allocation.
For example, the 2040 fund was almost 90 percent invested in listed property and equities at is launch last year. This exposure will be reduced to about 40 percent as the targeted retirement date of 2040 approaches, depending on the fund manager's view of the markets.
Another advantage of the Target Retirement Funds is that you can leave your money invested for up to 20 years after your retirement date, so you do not have to sell your stake in, for example, equities when you retire. This is made possible by Discovery Life allowing you to move your underlying investment into a Discovery Life retirement income (pension) plan on retirement.
In its Escalator retirement product, Discovery Life has taken a different approach to guarantees to other life assurers. Rather than providing a capital guarantee, which really applies only at your retirement date, it provides a guarantee of 80 percent of the highest market value your fund reaches over the term of your investment.
New lease of life for living annuities
Your investment-linked living annuity (Illa) is now far more likely to provide you with a sustainable pension than it would have done a few years ago.
The Life Offices' Association (LOA), which represents most life assurance companies, and the Linked Investment Service Providers' Association (Lispa) have drawn up a code of conduct to govern the marketing and selling of Illas to end the abuses associated with living annuities.
The vast majority of Illas that are sold are on the books of the members of the two organisations.
The code of conduct has been drawn up as a response to the increasing number of Illa pensioners who face destitution in retirement because of the cavalier manner in which Illas have been sold and the poor investment advice provided by financial advisers. These problems, which were compounded by unethical behaviour by many of the product providers, have been highlighted by the media, the Ombudsman for Long Term Insurance and the South African Revenue Service (SARS), which warned that it would withdraw its recognition of Illas if product providers did not make an effort to ensure that Illas provide pensioners with a sustainable income.
The code of conduct sets down parameters for Illa pensioners and product providers.
The introduction to the code states that the purpose of the code is to "provide industry standards so that linked annuities are responsibly marketed and administered, and that a linked annuity fulfils its originally intended design requirements while at all times producing a level of income that is sustainable for life".
Every product provider that belongs to either the LOA or Lispa must ensure that each linked annuity they administer complies with the code. Providers must also take steps to ensure that intermediaries comply with the code when dispensing financial advice.
The members of the associations have agreed they should not "exploit possible loopholes in the wording of the code, and should strive to comply with the letter and the spirit of the code".
The code seeks to ensure that your money is invested wisely and that you receive a pension for life. To achieve this, the code covers the following:
- Health warning.
You have to sign off on a health warning that clearly states you have understood the risks you are assuming. The health warning reads:
"Your linked annuity investment provides you with the flexibility, within the constraints imposed by the relevant authorities from time to time, to select your income to best suit your personal, financial and retirement needs. It therefore forms a key part of your own retirement income planning process and portfolio.
"Linked annuities should provide you with an income for life, and it is your responsibility to ensure that the level of income that you have selected is at a level that would be sustainable for the rest of your life.
"The table shows indicative initial annual income levels for guaranteed single-life annuities, with a five-percent escalation rate and no guaranteed term, for different ages.
"You should compare your current age to the table. If your selected drawdown percentage is above that reflected in the table, you are at risk of not having enough capital to support such a level of real income for life.
"It is important to note that the table is based on life annuity rates where the insurer carries the full investment and longevity risk, in contrast to a linked annuity where you carry both of these risks in full.
"If you survive for a longer period than the average life expectancy on which these rates are based, you could also run out of capital. The income drawn from your linked annuity is not guaranteed and will be affected by the investment performance of the funds that you have elected to invest in."
- Drawdowns.
In terms of current SARS directives, you must draw an annual pension that is between 2.5 percent and 17.5 percent of your capital's annual value. The annual income levels must be such that your annuity will be able to produce a meaningful pension for life.
The table here contains indicative drawdown rates that should ensure you will have a meaningful pension for life.
The rates, which are revised every year, are based on the average compulsory single-life annuity, with no guarantees and a five-percent escalation rate, from at least three product providers.
Members of the LOA and Lispa are obliged to tell you at least once a year the appropriate drawdown level, based on the table. On each anniversary of your policy, you must be warned in your statement what income selection rate could place the sustainability of your pension at risk.
- Appropriate investments.
At the time of going to print, Lispa and the LOA had not reached an agreement on this point.
To ensure that undue investment risk is not taken on the point of retirement, Lispa wants both associations' members to ensure that at the inception of an investment and at any subsequent switch, the assets selected by every Illa pensioner follow the prudential investment guidelines for occupational retirement funds set out in Regulation 28 of the Pension Funds Act. The investment limits include:
* A maximum exposure to equities of 75 percent;
* A maximum exposure to property of 25 percent;
* A total exposure to equity and property investments that does not exceed 90 percent;
* No more than 15 percent of the assets may be invested outside South Africa; and
* A maximum of 25 percent of the assets may be invested in fixed-interest instruments.
But the LOA feels the prudential guidelines might not be the correct advice in all cases, and would prefer a general disclosure that warns you of the investment risks.
With the lack of agreement between the LOA and Lispa, the investment limitations currently apply only to new Lispa investments as of December last year. At the discretion of a member of either one of the two associations, the limits may be waived, but only if an Illa pensioner is advised by a financial services provider licensed under the Financial Advisory and Intermediary Services Act.
- Transferability.
An Illa may be transferred from one product provider to another at the request of a pensioner.
- Convertibility.
An Illa may be converted to a conventional life annuity that is administered by the same life assurance company or by another assurer.
- Monitoring.
Every year, product providers must report to both associations on the ages and drawdown rates of their Illa pensioners to ensure that the standards of the code are being adhered to.
This article was first published in Personal Finance magazine, 2nd Quarter 2008. See what's in our latest issue