This is one of a series of 8 chapters which we hope will stimulate thought around the difficult issues that people may face while investing in retirement. Spire Platform Solutions does not provide advice and does not advocate any particular investment solutions.
In the first chapter of this series of articles we compared the benefits and risks of investing for retirement income into either Corporate Bonds or an Annuity.
It is clear that an Annuity does mitigate longevity risk as its maturity date coincides with the date of the purchaser’s death hence insuring that they always have an income in retirement. Additionally the security of the income provided by not only the insurer but also the FSCS means that we can even use the term ‘guaranteed’ when talking about the income.
So whilst annuities clearly provide the benefit of offering longevity management they are primarily positioned as an alternative to an Income Drawdown asset portfolio. At Spire we believe this positioning should have disappeared at the time of Pension Freedoms and in reality an Annuity is just an asset that can be used to build a Retirement Income portfolio.
In theory this has some benefits, however what would happen in practice?
In a White Paper written by the Actuarial Consultants Milliman in October 2018 entitled ‘Annuities reinvented’ they looked at what would happen to a portfolio if the Corporate Bond and Government Bond holdings were switched with an Annuity.
Within the Executive Summary of this work they state: "For those enjoying a long life in retirement, our analysis revealed clear benefits to annuitising part of the retirement pot. The strategy resulted in a higher likelihood of maintaining a target annual income and also, somewhat surprisingly, a higher average death benefit."
In order to bring this to life Spire has created our own deterministic model to look at the impact of investing into an annuity rather than fixed income investments. The case study shown below provides for some very interesting reading.
The projection on his portfolio value and income are shown in the 2 graphs below:
So the outcome is very interesting. The first graph shows the value of each portfolio as income is withdrawn over time. There is an initial drop on the Adjusted Portfolio when the Annuity is purchased, however, overall the capital value lasts longer than if the Standard Portfolio had been purchased. In this example Bill’s Standard Portfolio runs out just after he is 87 which co-incidentally is his average life expectancy – so he has a 50% chance of living beyond this.
The second graph shows the income he would receive. The orange line is the income generated from the
Standard Portfolio. As you can see when the Standard Portfolio value runs out his income stops. The bars
show the income generated when an annuity is purchased as part of the Adjusted Portfolio. The green bar
is the amount of income generated from the Annuity and the yellow bar the income from the Adjusted
Portfolio. When the Adjusted Portfolio value runs out the guaranteed lifetime income from the annuity
continues to pay out until Bill’s death, which he hopes is a very long time away.
Seeking to manage longevity risk within a portfolio has, for a long time been a real issue. Perhaps the solution has been with us all along.
By Adrian Boulding - Chief Innovation Officer at Spire Platform Solutions.