Greater need for fairly priced pensions

Laura du Preez | 08 November 2023

Laura du Preez has been writing about personal finance topics for more than 20 years, including eight years as personal finance editor for two leading media houses.

Most guaranteed annuity rates offered by life insurers to individuals do not take income into account, which disadvantages lower-earning retirees.

Low incomes have an affect on long-term health which results in lower earners on average dying younger than higher earners.

You would therefore expect that life insurers would offer lower earners cheaper annuities – more income for each rand paid, two actuaries who recently researched the annuity market say.

A cheaper annuity means a higher annuity rate or higher starting monthly pension for every rand of retirement savings you use to buy this kind of retirement income.

The fact that many insurers price pensions only on the basis of retiree’s age and gender and not according to their earnings is unfair towards low-income earners, Joanna Combrink and Dale Taylor, from Actuarial Benefits and Consulting Solutions, say.

Combrink and Taylor set out to test National Treasury’s statement that guaranteed life annuities do not offer good value for lower earners at retirement.

They presented their research findings at the recent Actuarial Society of South Africa Convention held in Sandton.

Fair rates increasingly important

At retirement, pension and retirement annuity fund members are required to use two-thirds of their retirement savings to buy an annuity. Provident fund members are expected to buy an annuity with two-thirds of their contributions made after March 1 2021 (with an exception for some older members).

When the proposed two-pot retirement system is introduced, retirees are expected to have more savings at retirement to buy a pension. Combrink and Taylor say this makes it increasingly important that retirees are offered fair annuity rates.

The actuaries say that mortality rates – showing the average ages at which men and women from different income groups die – suggest that the difference in the rate of pensions offered to higher and lower earners could be as high as 30%.

This price differential was evident in data that Combrink and Taylor analysed from one insurer that does price its annuities on income.

The actuaries found that when retirement funds outsource in bulk the provision of annuities to members (in what is known as the institutional market), these pensions are priced using the retirees’ income. When this happens, higher-earning retirees pay up to 28% more per rand of pension than lower-earning retirees, Combrink says.

When retirees buy their own pensions at retirement in what is known as the retail market, income is not used in the pricing of the pensions. All retirees – whether they are high or lower earners – pay the average price.

The actuaries also found that within an insurer, lower-earning retirees would be charged up to 37% more if they bought the pension themselves in the retail market compared to what they would pay if their fund bought a pension for them from the same insurer at the institutional rate.

Consider the default options

All retirement funds are now obliged to offer retiring members at least one annuity selected by the trustees as a default annuity option. Many funds offer a guaranteed annuity – typically a with-profit annuity – as a default.

Combrink says if your fund offers a default guaranteed annuity, it is worthwhile asking for a quote to check if you wouldn’t get better value from an annuity offered through the fund than you could get as an individual directly from a life insurer or through a financial advisor.

The outcome will be different for each member and fund, but it is likely that lower-income earners will be able to access better value through their fund’s default annuity, she says. In making any comparisons, however, ensure that the terms of the annuities compared are identical, she adds.

Health makes the difference

Deane Moore, CEO of Just SA, an annuity provider that prices annuities on more than just gender and age, says health is the most important factor that should be considered when pricing an annuity.

Health drives longevity, and income and lifestyle are just used as proxies for the probability of you suffering poor health later, he says.

Moore says life insurance policies you take out before retirement are priced on health, lifestyle and income and if your risks are higher you pay higher premiums.

But at retirement, retirees suddenly all become “standard risks”. This does not align with the principles of Treating Customers Fairly because those with higher risk factors should receive higher guaranteed income over their shorter life expectancy.

When annuities are priced on health, lower earners typically do get a better rate, he adds.


Little competition on individual rates

Combrink and Taylor also found that annuity rates offered to individuals are made public and there is only about a 5% difference between the rates offered by the different insurers.

Institutional rates on the other hand are not made public and there is more competition. The price differences between insurers rates ranges between 20 and 24%, Combrink and Taylor say.

The pair agree this means trustees of retirement funds choosing suitable annuities as a default option for retiring members can exploit these pricing differences.

Guaranteed annuities not favoured

Guaranteed life annuities, that guarantee you a pension for as long as you live, are just one of two options retirees can use to provide a pension at retirement.

At retirement, members can also invest their savings in an investment-linked living annuity and draw an income from the underlying investments. These annuities are favoured by 90% of retirees because when the pensioner dies, remaining capital can be left to heirs. Read more: What kinds of annuities (pension) can I buy when I retire?

But Combrink and Taylor say living annuities are complex for retirees to manage and, more importantly, these products transfer investment risk and the risk of outliving your capital to retirees. Read more: What are the risks when drawing retirement income from investments?

Retirees using living annuities need ongoing advice on investment selection and the rate of income to draw to ensure the pensions are sustainable, they say. The fees are also higher. They are therefore not suitable for most members, and they are particularly not suited to providing income security in retirement to low-income earners, the two say.

Combrink and Taylor’s research showed that very few retirees invested more than R5 million to buy a guaranteed life annuity over the four years to the end of 2021.

The guaranteed life annuity book of five large local insurers shows more than 400 000 retirees have guaranteed life pensions of R2 500 or less a month. Higher pensions are enjoyed by only about 10% of the annuitants and mostly at lower monthly values between R2500 and R20 000 a month.

The data also showed that more than 90% of retirees using guaranteed life annuities do not have any protection from inflation as they choose level annuities.

Level annuities offer the highest starting pensions but these pensions do not increase no matter how long you live. If your retirement years are long, a level pension will be seriously eroded by inflation.