• Bruce Cameron

Hybrid annuities: Something to consider when choosing your pension

The best news often follows the worst. But the best news may take some time to arrive. The worst news in financial markets often comes from unexpected events, such as the international 2008/10 meltdown as a result of the American sub-prime property crash. This has now been followed by the Covid-19 pandemic, which is expected to have a much larger and longer financial impact.

Pensioners are particularly at risk in times of volatile markets, not only in South Africa but around the world. The market crashes have affected both those starting their retirement and those already in it. While markets have recovered more recently, they have not fully recovered and further risks remain.

Too often in the financial world we have seen that vested interests of advisers, and those of large financial companies, play a huge role in undermining the financial interests of individuals.

Take the following examples:

  • Unit trust money market funds were strongly opposed and retarded by banks. The reason was the banks had a fine business locking peoples’ money up for long periods.

  • Life assurance companies came out fighting and lost out when people switched from secretive, high cost and poorly priced guaranteed annuities to living annuities.

  • The active management versus passive investment approach. For quite a long period, it was a war with one totally opposed to the other. The vested interests that opposed passive management of funds were making a fortune by charging a lot more for active management. What is now being gradually seen is that a mixture of the two, driven mainly by retirement funds, will give the best returns.

It is not a question of which annuity is better – a guaranteed annuity or a living annuity. The answer lies in both. It is something that I have been arguing for many years.

In December 2019, a group of British and American academics published a paper on what is called the “sequence of returns” for people living off their accumulated investments. This was research based on the 2008/10 market crash.

The paper, “Developing a Measure of Sequence Risk”, was written by Andrew Clare, Simon Glover, James Seaton, Peter N Smith and Stephen Thomas. It is a technical paper, but you can download it off the website. In simple terms, this paper is saying that neither living annuities nor guaranteed annuities should be seen in opposition to each other.

In simple terms, this paper is saying that neither living annuities nor guaranteed annuities should be seen in opposition to each other.

The answer lies in what are hybrid (flexible) annuities, which mix and match the annuity types – both linked investment living annuities and traditional guaranteed annuities must be combined.

Those pensioners who have already done this should find themselves in a better position following the Covid-19 crash.

John Anderson, who heads the Alexander Forbes research team, says these mix-and-match hybrid annuities will help pensioners, many of whom have saved too little for retirement.

“Hybrid annuities will help to optimise the pension benefits to balance the competing objectives pensioners face. Hybrid annuities provide a sustainable income on the one hand, versus having flexibility for unforeseen events and the ability to leave an inheritance on the other,” he says.

All retirement annuities, both guaranteed and living annuities, are in fact life assurance policies. They can, by legislation, only be sold under a life licence. So what you will find is that even asset management companies, such as Allan Grey, Coronation and Sygnia, all have life assurance companies, or will use the services of another life assurance company. It is not just the big life assurance companies who sell them.