Annuities and Retirement Planning — Longevity Risk


A closer look at annuities and retirement planning in the context of Singapore

Annuities get very little respect because they are portrayed as expensive and loaded with sales fees. However, a rapidly aging demographic and declining real wages has jeopardised the current projections for government led pension plans. It is not easy to supplement retirement with private wealth management plans because the state cannot mandate how much citizens save beyond the scope of pension policy.

Life annuities are crucial because they hedge against longevity risks and medical expense risk. In fact, annuity payments should be inflation indexed. Life annuities have monthly payouts. The stream of cash flows can be replicated by a mix of bond payments. It does seem like bond yields may no longer be able to match up with the required annuity yield. To meet the annuity payouts over a longer time, annuity managers may need to introduce risky products like equity index funds into the portfolio. But it is unclear if citizens are open to endure the high risk.

In Singapore’s context, I am less sure if Singaporeans are preparing for longevity risks. Should they expect to systematically live longer, to say, 90 year old, the consumption save must reduce tremendously. Practically, a young professional who expects to live till 100 will need to start investing in equities as soon as he starts work.

It is incorrect to think that life annuities are expensive products if we assume Singapore is a competitive market for annuities. In a competitive market, we can assume that longevity risks and recent demographic trends are priced into these financial products.

There are ways to reduce premiums for annuities. The larger the insured pool, the lower the premiums. For one, the fixed costs will be reduced. The pooled risks approach a normal probability curve. This implies that Singapore government’s mandatory annuity policy is in the right direction from a policy point of view. But the policy makers should introduce the annuity programme with a softer approach. Perhaps annuities need not be made mandatory right at the start. In fact, the government can communicate the benefits of annuities and highlight the financial risks of not subscribing to an annuity.