Comparing SA annuity options at retirement. Paper published in the Journal of Economic and Financial Sciences (May 2014)

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1 Comparing SA annuity options at retirement Paper published in the Journal of Economic and Financial Sciences (May 2014)

2 Introduction: Background 2 Background to the study Most individuals purchase either a life or a living annuity. This decision is often made without quantifying the potential benefits and risks of all the annuity options on offer (Goemans and Ncube, 2008)

3 Introduction: Goal of study 3 To compare various annuity strategies in order to ascertain which strategy would have been superior, by looking in the rear view mirror To aid retirees in selecting the most beneficial annuity strategy/strategies

4 Introduction: Goal of study 4 It was established which of various annuity strategies would have been best to follow by SA males aged 55, 60 and 65, who retired in each of the 30 years from 1960 to 1989

5 5 Introduction: Goal of study Present values of the monthly cash flows provided by 47 annuity strategies were calculated in order to ascertain which strategy provided the largest financial benefits in present value terms Annuity strategies: 9 living annuity strategies (3 drawdown strategies combined with 3 asset allocations); 2 life annuity strategies (a level annuity and an annuity increasing by 5% each year); 18 composite annuity strategies (9 living annuity strategies combined with 2 life annuity strategies); 18 switching annuity strategies (9 living annuity strategies switched to 2 life annuity strategies)

6 SA literature review 6 Study by: Goemans & Ncube (2008) Lodhia & Swanepoel (2012)

7 SA literature review 7 Both studies compare various annuity options available to SA retirees by employing a forward-looking approach In contrast, this study compares various annuity options historically for a SA retiree who retired during the period 1960 to 1989

8 Data 8 Bond market index data was obtained from the database compiled by Firer & McLeod (1999) Equity market index data was obtained from the INet-Bridge database CPI data was obtained from StatsSA Life annuity rates were provided by Sanlam

9 9 Methodology The discount rate used to discount cash flows of an annuity in month n was the geometric average of the inflation rates through months one to n, as follows:

10 Methodology 10 The present values of cash flows were calculated per R1 million invested Male annuitants retired at the beginning of every year Life expectancy determined according to a(55) life mortality table, as follows: Age Life expectancy 21 years 18 years 14 years Remaining capital at death also discounted to a present value

11 Methodology: Living annuities 11 For living annuity strategies the present values of cash flows for 810 combinations were calculated Asset class Risk Profiles Conservative (A) Moderate (B) Aggressive (C) Equity 25% 50% 75% Bonds 75% 50% 25% Age Initial drawdown rate 5.5% 6.2% 7.3%

12 12 Methodology: Living annuities Drawdown strategies: - Maintaining the same drawdown rate (a) - Adjusting the drawdown rate each year to increase the Rand amount of income by 5% per annum (b) - Adjusting the drawdown rate each year to increase the Rand amount of income by the annual inflation rate (c)

13 13 Methodology: Living annuities Costs: - Underlying base asset management fee including VAT of 1.4% p.a. on the equity portion of the portfolio, and 0.9% on the bond portion of the portfolio - Annual adviser s fee including VAT of 0.57% p.a. - LISP fee of 0.25% p.a. Portfolios were rebalanced annually

14 14 Methodology: Life annuities For life annuity strategies the present values of cash flows for 180 combinations were calculated Two strategies: - Level annuity - 5% increasing annuity Single life & 10-year guaranteed term Initial commission including VAT of 1.71%

15 Methodology: Composite annuities 15 For composite annuity strategies the present values of cash flows for 1620 combinations were calculated (9 living annuity strategies combined with 2 life annuity strategies) Life and living annuity strategies combined on a 50/50 basis

16 Methodology: Switching annuities 16 For switching annuity strategies the present values of cash flows for 1620 combinations were calculated (9 living annuity strategies switched to 2 life annuity strategies) Living annuity strategy was switched to a life annuity strategy 10 years after retirement

17 17 Results Four KPI s were developed: Average rank Best rank Number of victories 20 th, 40 th, 60 th and 80 th percentile Results (55) (60) (65)

18 18 Results Using average rank as the determining KPI Overall best performers: Age 55: Liv-C-b-55 Age 60: Liv-C-b-60 Age 65: Liv-C-a-65 Overall worst performers: Age 55: Lif-5%-55 Age 60: S(Liv-A-a-60-5%) Age 65: S(Liv-A-a-65-5%) Bar chart results (55) (60) (65)

19 Conclusions 19 Living annuity strategies are superior to composite annuity strategies, which in turn outperform switching annuity strategies A retiree would have been worst off had he invested all of his money in life annuities This conclusion is in contrast to the 2 South African studies

20 20 Future possibilities for research No explicit risk measure used - Number of times a cash flow payment did not meet a certain benchmark level, after which the size of such shortfall could be determined Other discount rates could be pursued

21 21 Thank you! Jeannie de Villiers-Strijdom CFP

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