Income annuities as an alternative to bonds

Totally agree with the scenario you mentioned. One clever way to maximise the benefit which I never thought of. Thanks for sharing.

 

A few years ago I did some marketing work for Challenger and was given deep dives into the pluses and minuses of annuities. The only other provider in Oz is/was Comminsure, part of CBA. Others relabel annuities from those two.

Basically, they should not be compared to equity investments or diversified funds. They are fixed income. And like most other fixed income investments these days the potential return has dropped as interest rates have dropped.

So a Challenger Lifetime Annuity is an income-guaranteed insurance bond that pays you (ostensibly and currently) 3.7% on your initial lump sum for a 65 year old. However, since you lose your capital, the actual rate of return is rather lower than this.

And if you buy now you are locking yourself into low returns for the duration.

Your investment (in Australia) is not guaranteed by the Government or anyone else. It is guaranteed by the annuity provider. Challenger is a large solid company, but their shares are down 45% this calendar year. The largest shareholders are Citibank, HSBC and JP Morgan.

Normally I'd trust CBA more, but they recently sold the business to AIA.

But that isn't the fundamental problem.

If you have a lump sum, earn no interest on it, and simply withdraw 4% (of the initial amount) a year it will last for 25 years. So $1M will give you $40K a year for 25 years. If you withdraw 8% it will last 13 years. So a theoretical 82 year old can withdraw $80K a year until they turn 97.

Challenger currently guarantees you $47K a year on $1M. Or $7000 more than zero interest. Which translates to a .7% return. About the same as sticking the money in the bank.

If I come across as overly negative it is because there is really little to recommend an annuity for most other than simplicity and dubious of peace of mind.

For those who qualify, as mentioned by Ross36, there is a benefit in their generous treatment for the aged pension. But it is a rather narrow window, and I would not be at all surprised if the Government closes it as part of the inevitable deficit squeeze.

As has been pointed out there is currently a real dilemna for those who are retired and whose main concern is not going backwards. Shares are too volatile and, if not in a bubble, seem to have far more room to drop than grow. Bonds have, less ostentatiously, been on even more of a tear but are at risk of even the slightest nudge up in rates. Cash pays bugger all

But locking your loot into an annuity to get .7% more than bugger all seems a bit rich.

 

Useful to know thanks. There's a big difference between comminsure and AIA.

Agree 100%. Other than the small window I described (elderly, pension optimised, some money but not unlimited and likely won't last forever) I don't really see the value.

I wonder though if the government won't consider their own annuity style "product" to support pensioners in the future. The USA approach of letting you delay your pension to increase how much you get makes sense to me and is annuity like. The pension loan scheme is pretty much a reverse mortgage controlled by the government to get the dodginess out of the space.

 

Very,very interesting read @sfdoddsy thanks for taking the time to post such a lengthy explanation.

 

The point of annuities is that an individual can not guarantee they have enough money if they live longer than average, but an entity providing it to a large group of people is able to do so because those dying earlier offset those dying later and they to average over a large group size.

Your 0.7% is with the false assumption that you die at exactly that point in time.
Once you remove that false assumption, your calculation of 0.7% more when comparing it to fixed income no longer makes any more sense than comparing it to equities.

Similarly with the person who bought an annuity and died 2 years later without mentioning the other side of the coin being those who purchase it and live for many years longer than expected. The person who died 2 years later is one data point and hides the entire value of the concept of annuities, which is to be able to guarantee income no matter how long you live because an entity can reduce your risk by way of having a large group of people to average from whereas an individual simply has no ability to do so.

Annuities are not suitable for everyone, but these comments leave out half the story. More than half the story actually, since the entire point of annuities was left out.

 

Thanks for your post. @exp. good contribution.

Annuities are basically a pooling mechanism to protect against longevity and sequence risk. They should be seriously considered by many people at the appropriate time who are susceptible to those two risks, which in reality will be most people.

Education level of those self-managing their retirement finances has miles to go before the retail annuity market matures into its potential.

When starting yields are low and life expectancy is improving the risk of running out of money is increased, hence why the cost (low implied returns) of insuring against the risk is currently high. You can ignore the risks, but they do not go away. If you don’t have a large starting capital base to deal with the risks and you choose to not insure, best start hoping for an early death, good market fortunes or a caring government safety net to balance the realities.

As government funded pension is the backstop to those that run out of money, inducements by way of pension asset test reductions to insure privately via annuities is likely to remain.


Ps AIA is HK listed Insurance giant with larger Market Cap than CBA.

(Disclosure – Invested in CGF)

 

The people making money out of Challenger are the shareholders with a wealth transfer from annuity holders. Shareholders who bought 10 years ago probably getting 10% + yeild and even after 70% price fall still had 100% GC. Buggered if I know why people would be clients instead of owners but somebody has to be the sucker. To put it another way you would only need to invest 20% of what you would as a client, in ownership, to get better returns. Holding 50% as cash and 50% as share holder would be safer, less volatile and more lucrative.

 

i agree with this, my thoughts are that no government wants to see their elderly struggling to make ends meet. Whether thats a moral thing OR because its such a powerful voter base....

I'm more concerned with who would lobby parliament for the annuity exemptions now that commbank has less of a stake in the game. The annuity asset test for the pension changed this past year and may well change again, so it would be good to know there's a vested interest with a mouthpiece.

Personally though for the situation ive described prior an annuity seems a no brainer choice. Longevity risk is the biggest concern, this hedges it better than anything else I've seen. IF the rules change for the worse they may well be grandfathered anyway. IF the concern is insurer risk than split it amongst companies. A weird quirk I noticed when I asked for quotes was that smaller investment amounts had (very) slightly higher yields so multiple annuities is not a bad thing.

 

Bold by me.

The only thing I would add is to define your amount of "large starting capital base". If you are drawing down no more than about 3% (or a bit more with contingencies such as ability to cut discretionary spending), then you may be able to consider your starting capital base to be large enough to not need to consider SOR protection such as a considerable helping of cash/bonds/annuities. How many people realistically are going to retire in this position. I would say extremely few, even on this forum.

 

If I recall, Swedroe recommends considering annuities no sooner than 70 years of age.

Also, not everyone wants to leave a huge amount of money behind. Many will want to enjoy what they have sacrificed all their life, and an annuity gives the option to essentially draw down to zero by the time you die rather than having to end up dying with a whole lot of money to avoid going bankrupt when you are old.


I would be great if @Simon Hampel would move the annuity posts to it's own thread so that it is easy to find/discuss. I would appreciate having an easily searchable place to find posts by informed people such as Ross.

 

Ouchies for shareholders according to an acquaintance who sent me this snippet from some news article.

"Funds management group Challenger was stung by a $750 million collapse in the value of its investments, pushing the company into the red, as the group looks to reinvigorate its flagging annuities business in Australia, where sales sunk by more than $1 billion."

 

For somebody that proclaims to not be interested in direct shares that’s a pretty sad topic of conversation.

As noted in above disclosure I’m a CGF holder and I don’t have a particular problem with the results. I find the media take interesting and the fact that its worthy of discussion by people with idle passing interest that conclude “ouch”. Not that I should complain as I like to buy t-shirts in winter.

Just to make their results a bit more comprehensible for a LIC investor, lest they have the wool pulled over their eyes by the media.


CGF’s normalised profits would be comparable to MLTS income from operating activities.

MLT was down 20% to 126M

CGF was down 13% to 344M


CGF’s Investment experience is best compared to MLT’s Revaluation of investments.

MLT was down 300M after tax

CGF was down 750M after tax.

Accounting standards require CGF to pass investment returns including unrealized revaluations through the P&L and report it as statutory income whereas MLT can take them straight to the balance sheet and does not report capital gains/losses in statutory results.

The full picture on Annuity sales. Yes Aus domestic was down 0.9B (27%) but overall FY20 was up 0.6B (13%)



I hope your acquaintance is not relying on media reports for his investment decisions. No wonder you have to talk about coffee and guitars on an investment forum when you talk to real life people about investments. I must have it all back to front, because I would rather talk about anything in person than investing.

 

Some slides from CGF presentation today that may be educational for this thread.

 

Ta. I'll pass this info on and suggest he get advice from a qualified professional.

Probably he'll need to set up a Special Purpose Trust for one of his kids who has Friedreich's Ataxia rather than looking at annuities.

 

A special purpose trust is a structure for investing with special tax considerations for beneficiaries whose disabilities qualify.

Annuities are investment products that can offer income sucurity which the trustee of the SPT may (or may not) find appropriate in undertaking their responsibilities as trustee.

Hope your acquaintance gets some good guidance with looking after the long term needs of their child.

 

Thanks for sharing these slides - the "combining products" one on the top sums it up very nicely, as does the bottom slide showing the income floor an annuity + pension provides as you age.

For anyone interested in going deep into the nuts and bolts of annuities check out wade pfau's work. It's USA focused, but some of the points he makes are fascinating. Something I'd never thought of is to use a small portion of your wealth to buy an inflation protected annuity as a DCA type mechanism for purchasing other investments. In a nutshell you buy the annuity then use the income each year to purchase other investments (eg shares). This can help resolve some of the sequence of return risk. In times where there is a large downturn and dividends are cut your income from the annuity remains consistent, allowing you to take advantage of depressed prices. Or you use the income stream to top up your dividend / reduce share sales to cover your cost of living.

I think it's easy to forget just how bad equity returns can get for very long periods of time. Those aussie share return graphs from the 1970's are ghastly. Being in the drawdown phase on a portfolio that was mostly equities at that time would have been a nailbiting experience. Anything that can be done to "smooth the ride" is at least worth considering for me.