Q&A: How safe are annuities as an investment? December 31st, 2022
I have been looking at retirement options and note the renewed interest in Annuities. It seems that recent interest rate rises mean they are now more attractive than a few years ago.
While interested, I am still concerned about the risk associated with handing over a lump sum of money to a company and being certain that they will be around in 20 or 30 years to keep the payments coming. You mentioned that they are heavily supervised by the government.
Can you provide a bit more detail about these safety measures?
Can I get my question answered?
An annuity is essentially a contract between you and the annuity provider where in exchange for a lump sum amount, the annuity provider will pay you a set amount over a period of time. You can choose the frequency whether it is monthly, quarterly, six monthly or annually. The annuity payment includes an interest component and in most cases, a portion of the original capital you invested.
With this type of annuity, the annuity eventually runs out at a known date in the future. The annuity you are referring to however, is a life-time annuity where the payments continue as long as you live and are usually indexed to the inflation rate.
If you live to 105, the annuity will still be making payments.
Annuities can only be provided by an Australian Registered Life Insurance company which must satisfy particularly strict criteria. Life Insurance companies are regulated by the Australian Prudential Regulation Authority or APRA which closely monitors other institutions such as banks and superannuation funds.
Life Insurance companies as annuity providers are required to have a special “Statutory fund” established which is designed to cover all the liabilities of the annuity provider. Under APRA’s supervision, if there is a shortfall, the provider may be required to add additional money to the statutory fund or can be directed to change the investments.
Statutory funds are typically required to demonstrate that they could still meet their liabilities in the event of a 1 in 200 year economic event occurring.
It is important to note that this regime has meant that no Australian Life Insurer has ever failed.
Older companies such as the AMP Society, National Mutual, Colonial and others, all survived catastrophic financial events such as World Wars 1 and 2, the Great Depression and the Global Financial Crisis.
For these reasons, the only Australian providers currently able to offer retail annuities include Challenger Life and AIA Australia. Other companies may offer income product variants but in this case, the investor generally wears the market risk of the underlying investments.
However, while annuities are heavily regulated, an annuity is not guaranteed by the federal government. These guarantees are restricted to deposits with Authorised Deposit taking Institutions or ADIs.
In this case, the first $250,000 per account holder per institution is covered. This scheme is also supervised by APRA in the event it was triggered.