Will it be feasible to use a living annuity as part of your default annuity strategy?

By Denver Keswell

On the 8 June 2020 the FSCA published the Draft Conduct Standard of 2020: Conditions for Living Annuities in an Annuity Strategy. 

This draft Conduct Standard is proposed in lieu of the recent regulations released which sets the guidelines for a board of trustees (the board) when using a living annuity as part of their default annuity strategy. More specifically Regulation 39(3)(a) states that drawdown levels of living annuities that form part of the annuity strategy of a fund must comply with a prescribed standard. This draft standard seeks to introduce guidelines for a living annuity used as part of a retirement funds default annuity strategy.

When can the board use a living annuity as part of its default annuity strategy?

The draft standard requires the board to consider the funds “most appropriate proposal for the average member from a specific category of members of that fund” in determining the annuity strategy. In doing so it must further consider individual risks that threaten the sustainability of pensioners income such as:                   

  • retirement savings being depleted too soon
  • (the potential for) poor investment returns on capital; and 
  • excessive fees and charges

In addition to the living annuity being appropriate for members the draft standard also requires the default annuity (using a living annuity) introduce more protection than if the member decided to purchase a “normal” living annuity in terms of their own research. Lastly the sustainability of the income provided by the living annuity needs to be regularly measured, monitored and clearly communicated to annuitants at inception and on a regular basis thereafter.

What are the boards responsibilities with regards to measuring and monitoring sustainability?

The draft standard places an obligation on the board to ensure that the income provided by a living annuity used as part of the annuity strategy is sustainable and monitor the sustainability of the income. It further sets out the way that sustainability can be measured by boards but ultimately requires that the sustainability of income needs to be measured by considering the continued payment of a determined income over the lifetime of a pensioner, whereby the income payments increase in line with inflation. The obligation of measuring and monitoring sustainability of income applies regardless of whether the living annuity is provided by the retirement fund itself or an external product provider. As the draft standard does not require that the amount provided by the living annuity is sufficient to support the income needs of the annuitant (only that it is sustainable over the lifetime of the annuitant), it therefore means that a default annuity strategy using a living annuity will not be appropriate for those retirees where the suggested income is not sufficient to survive on.  Considering this, it remains to be seen how successful a living annuity option will be as a default annuity.

How must the board communicate to members (annuitants)?

Boards must communicate to annuitants at inception regarding the “reasonably expected commencement income and drawdown rate and details on the risks and sustainability of that annuity” and thereafter at least on an annual basis regarding the “continued sustainability” of the income as well as any “warnings” regarding said sustainability. Where an external provider is used outsourcing of communications as well as oversight needs to be addressed.

What are the recommended drawdown rates?

The draft standard no longer requires that a fund must apply a maximum drawdown rate. Instead it requires that the board should use one table that it should aspire to and a second “maximum” drawdown limit table that a fund should use to encourage members to apply.

When must a board comply?

The standard is still in Draft and will only take effect on date of publication. Retirement Funds will have 6 months thereafter to comply with the standard. The regulator has afforded interested parties the opportunity to comment on the draft standard on or before 31 July 2020.