Comment

We have all seen television advertisements showing couples enjoying themselves in their golden years because they had the foresight to invest in that particular insurance company’s pension plans.

The whole focus is on accumulating enough money so that on retirement, the kitty can be used to generate money on a regular basis. The entire industry’s focus has been on the savings phase (also called accumulation phase in industry speak) of the pension plan.

There is very little interest or discussion on what happens when you actually retire and need the money to be paid out to you on a regular basis (called the annuity phase).

Now, chances are that you may not know anybody who has used his accumulated savings to buy an annuity. The reasons are not very far to seek.

Look at the risk-free returns that an individual can get from the various options for a person who is 60 years of age.

As can be seen, people with accumulations below Rs 25 lakh or so are able to get far better yields from government schemes than what they would get if they were to buy an immediate annuity.

Even for amounts greater than Rs 25 lakh, the return from ultra-safe bank fixed deposits would beat the returns on an annuity plan. I am not even taking into account government bonds, mainly because of the difficulty for an individual to buy them from the market.

Of course, all these savings schemes run for a limited period (6-10 years) and interest rates will be reset at the then prevailing rates after they mature. The customer also has an option of investing in long-term income schemes of mutual funds which, though not providing a guaranteed return, have yielded around 8.50-10% per annum over the last five years or so.

No wonder then that the participants of corporate superannuation schemes (who have no choice) have been the only significant purchasers of these annuity schemes so far.

The National Pension Scheme (NPS) now has about a million accounts and it is expected to gather pace from next year due to the proposed changes in the direct taxes code. The NPS account holder has to use most of the amount in his fund to compulsorily buy annuities from insurance companies.

Also, Irda has proposed to make it compulsory to buy annuities from insurance companies for at least two-thirds of the fund value for pension plans issued after September 1, 2010. Therefore, the relatively poor returns from these schemes will soon cease being of peripheral interest, and will need to be looked into.

One reason for the lower return is that annuities — which are in the nature of interest paid on the sum invested in annuity schemes if we consider only those scheme that provide life-time annuity and return of purchase price after death — are guaranteed for the lifetime of the person buying the annuity.

So irrespective of the interest rates that the scheme itself is able to get, the insurance company still pays a guaranteed return to the purchaser. Longer the period of the guarantee, higher is the risk of mismatch between the actual returns of the scheme and the guaranteed returns.

Obviously, the insurance company needs to keep a cushion to absorb any drops in future interest rates when it works out the annuity payable to you over your life time. That’s where the mortality tables used by the insurers comes into play.
In an analysis of schemes offered by LIC, ICICI Prudential Life and Bajaj Allianz, we found some interesting facts.

We compared the lifetime annuity schemes of these companies for both scenarios — where the purchase price is returned on the death of the purchaser and where it is not (obviously, the annuity is far higher for the second option). We assumed the person to be 60 years of age and the purchase price of the particular annuity at Rs 50 lakh. See table ‘Annuity offers’.

The insurance companies clearly think that people who buy annuities live far longer than an average Indian.

Only, they have the data necessary to find out the life expectancy of the annuity buyer. It is a definite fact that the life expectancy of people who buy annuities will be longer than the average Indian.

In fact, Steven Levitt and Stephen Dubner, in their book SuperFreakonomics (Page 82) talk about this and I quote “… People who buy annuities, it turns out, live longer than people who don’t and not because the people who buy annuities are healthier to start with. The evidence suggests that an annuity’s steady payout provides a little extra incentive to keep chugging along.”

While this is written in the context of California pensioners, even in India, the people who buy annuities belong to that part of the population which has access to good medical and other facilities and will live longer than the general population.

Some major reforms are needed in this space since a large number of people will soon be forced to purchase such annuity plans. The returns they’ll expect will need to be much closer to the returns that senior citizens can get on their own from reasonably safe sources.

The government is doing its bit to increase the return on annuities by promising to exempt “approved annuities” from tax in the revised discussion draft on the DTC. This will benefit the richer annuity buyers since they may be in the taxable bracket.

The writer is CEO, Apna Paisa, a search comparison engine for loans, insurance and investments. He can be reached at hrdna@apnapaisa.com