Most conventional life annuities are priced against just two factors that influence longevity – age and sex. Yet there is a host of other factors that should be considered in arriving at a fair price for each person.
This is one of the reasons that life annuities fell out of favour for over a decade. “People from lower income brackets started to question their value, and they were right,” says Deane Moore, CEO of retirement income specialists Just SA.
Unlike living annuities, life annuities provide a guaranteed income for life. This is achieved by risk-pooling to evenly spread the risk among policyholders (essentially how insurance works). A guaranteed life annuity’s total value is the sum of its starting income and the expected future increases over a long-term investment horizon. The question is how much income does each person receive? Or, looked at another way, what price does each person pay for an income for life?
A just price, based on individual risk
South Africa is a very diverse country with vastly different levels of economic opportunity, and access to healthcare, nutrition, and education. As a result, higher incidences of serious diseases such as diabetes and heart disease are more prevalent among those in lower income brackets. Consequently, those from poorer backgrounds tend to have a shorter lifespan than those who are wealthier. When the funds of a wide variety of people are pooled together in a conventional life annuity, the poor, who tend to die sooner than expected, subsidise those who live longer than expected – which is likely to be the wealthier policyholders.
In South Africa, where the differences between diverse segments of the population are so vast, it is not just to price as if they are. This was also recognised by Treasury in its series of retirement reform papers published between 2012 and 2014.
Underwriting holds the key
“People have a right to purchase a life annuity at a price that fairly reflects their individual risk,” says Moore. One way to achieve this is to use underwriting to find out a lot more about a retiree than his or her age and sex to assess their life expectancy more accurately.
While life insurance policies use medical underwriting to charge those who are ill a higher premium, life annuities use underwriting as a fair way of ensuring you get the right income, for life. This gives you confidence that you are getting the highest possible starting income for your retirement savings, which is important as any subsequent increases are based on your starting point.
When a potential client applies for any of the annuities that Just offers, they are likely to be asked a series of medical, income, education, and lifestyle questions. If their answers put them at risk of dying younger than the average person, their policy is priced accordingly. This could result in, for example, a 10% ‘uplift’ in their monthly income as they are only expected to live 18 years as opposed to 20 years.
“This is especially fair for lower income individuals as their chances of living a long life into their 80s or 90s are unfortunately limited by the factors we’ve mentioned,” Moore says.
In fact, over the past five years, 40% number of Just SA’s policyholders are enjoying a higher monthly income than they would have without any underwriting.
Underwriting for spouses
Something to understand is that if an individual wants to buy a life annuity policy and leave a legacy of an income for life for his or her spouse, both people will go through the underwriting process.
“If one of the spouses is ill, but the other is healthy, we have to take both lives into account when pricing the policy,” Moore concludes.