Solutions to provide “attractive” lifetime group annuities

The government is contemplating that all superannuation trustees should offer a flagship Comprehensive Income Product for Retirement (CIPR) to members at retirement, subject to some limited exceptions. 

CIPR’s will have to provide an income for life, and it is intended that a 100% allocation to an account-based pension alone would not meet the definition of a CIPR. Clearly an immediate annuity component would meet the definition, but worldwide experience is that these are capital intensive and unattractive, especially given the current low-rate environment. 

However, drawing on Canadian defined benefit concepts and the experience of one long-standing Australian Church-based defined pension plan, I believe that there is a solution whereby attractive lifetime group annuities can be provided as set out below.

The features presented below are based on a large superannuation fund and are for illustration only.

The plan sponsor could be a large superannuation fund or a life office and the features can be varied by the plan sponsor. Similarly, the plan sponsor could also be the government or a government agency.

1. The annuities are payable for life, are non-commutable and the targeted indexation each calendar year is 100% of the CPI for the previous year ending 30 September. Better still, to improve the product, and consistent with the Age Pension, the targeted indexation could be based on the greater of annual increases from the CPI and say AWOTE.

2. The annuities are purchased by plan members at retirement subject to a minimum age and a minimum purchase amount set by the plan sponsor.

3. Annuity rates vary by age and sex and are set by the plan sponsor based on the advice of the Plan Actuary (appointed by the plan sponsor). The annuity rates for the first tranche of annuitants (see point #7 below) will apply for at least 12 months.

4. Fees could be set at product level or tranche level with any variance of expenses, from the fees allowed for in the annuity rates, spread over all product or tranche members via the yearly indexation percentages and reported annually. The plan sponsor would decide the structure.

5. The plan’s investment policy would be set by the plan sponsor and could be the plan’s current Balanced option. If the plan sponsor is already providing account-based pensions it could be the investment policy (or one of the policies) of the current account-based pensions.

6. Each year, just before 31 December, the plan sponsor would advise annuitants of the indexation to apply as from the next 1 January, expressed as a percentage of CPI (or AWOTE if applicable) for the previous year ending 30 September.

7. If the percentage in point #6 above is between 50% and 200%, then annuity purchase rates for the current tranche of business will remain unchanged for a further 12 months. If the percentage in point #6 is not between 50% and 200%, then annuity rates for future annuitants will be changed and a new tranche of annuitants will commence. Reasons why the percentage might be less than 50% would be poor investment performance and/or very low mortality experience. Reasons why the percentage might be greater than 200% would be good investment performance and/or very high mortality experience.

8. If the percentage in point #6 is less than 25% then the current tranche of annuitants would be given the option of either:

• • Continuing within the current tranche of annuitants and taking the risk of whether the annual indexation percentage might recover to a level above 25% or continue to fall and perhaps even become negative; or

  • Having their equitable share in the fund (as determined by the Plan Actuary and with a constraint that, with the one basis applied to all members, the sum of all shares must equal the realisable fund value at or near the calculation date) transferred to a life office of their choosing and used to purchase a non-commutable lifetime annuity from that office.

9. Illustrations of the likely distribution of indexation percentages would be provided, using a stochastic investment simulation model, in all marketing material and plan reports. Annual movements in the indexation percentage are minimised by spreading surpluses and deficits, using say the aggregate funding method, over the future lifetime of all annuitants in each tranche, based on next year’s percentage (from point #6) remaining unchanged each year. Robust rules are essential about the treatment of surpluses and deficits. 

10. The Plan Actuary should advise the plan sponsor about possible adverse consequences from any anti-selection and advise about how to underwrite sub-standard lives.

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