By Professor David Babbel from the Wharton School at the University of Pennsylvania.
How to choose an annuity provider
If you are considering a risk-averse approach toward retirement funding, you should include an assessment of the reliability of your annuity provider.
Fortunately, Australia has more stringent capital requirements for annuity providers than most, thereby furnishing not only sufficient funds to cover a company’s expected commitments, but a sizeable cushion of excess funds in case projections don’t turn out as anticipated. Nonetheless, it is prudent to invest carefully.
In this regard, the U.S. Department of Labor has issued an interpretive bulletin relating to the fiduciary standards under Employee Retirement Income Security Act when selecting an annuity provider for a defined benefit pension plan.
These standards are designed for professionals who guide investment decisions, but also shed some light that may be helpful to individual investors. The type of factors a fiduciary should consider would include, among other things:
(1) The quality and diversification of the annuity provider's investment portfolio
(2) The size of the provider relative to the proposed contract
(3) The level of the provider’s capital and surplus
(4) The lines of business of the annuity provider and other indications of their exposure to liability
(5) The structure of the annuity contract and guarantees supporting the annuities, such as the use of separate accounts
(6) The availability of additional protection through state guaranty associations and the extent of their guarantees.
In my view, these guidelines provide a very good basis for assessing annuity providers in most countries around the world, including Australia.
For the non-professional, two good indicators of an annuity provider’s reliability are how long they have been in business and what their credit ratings are.
I also consider their surplus ratio (i.e. capital and surplus to liabilities). This important ratio measures the size of the provider’s cushion against unanticipated events.
Suffice to say that when you’re looking for a provider who can back up their promises for the remainder of your lifetime, you don’t merely look for the ‘best’ (i.e. lowest) annuity prices or (equivalently) highest payout rates.
In fact, that could be a negative indicator of quality if the insurer is aggressively looking to pick up volume by lowering price, unless it has a substantial surplus backing its promises and the discipline to close off the ‘special pricing’ when its surplus begins to be strained.
Providers like CommInsure, which has over 4 million customers and a 140 year+ history in the Australian insurance industry provide the scale and length of tenure that can help to give you peace of mind.
You can read more about CommInsure’s well diversified, professionally managed investment portfolio, strong balance sheet, capital adequacy, structure and guarantee behind their annuities and the innovative solutions they offer on their website.
Managing concentration risk
One smart strategy I employ is to diversify across carriers. For example, if you are planning to purchase $600,000 of annuities, you might wish to spread that money across a couple of strong providers.
There are three main providers of annuities in Australia, and a sprinkling of smaller players. You should study the quality of the providers before buying.
Professor David Babbel and CommInsure have written a white paper titled ‘Retire Smarter – new strategies towards a comfortable retirement’, which considers this and other issues in retirement funding in detail.
General advice only. This material has been prepared without taking into consideration your personal objectives, financial situation or needs. Before acting on this advice, you should consider whether it is appropriate for you. You should read the relevant Product Disclosure Statement before making a decision to buy or continue to hold a product. The Colonial Mutual Life Assurance Society AFSL 235035.