2022年は、金利市場にとって異例の年となりました。金利は、収入を提供するためのコストの主要ドライバーです。今や（最近の銀行危機は別として）金利がある程度安定しており、2つの主要な退職後の所得商品である個人年金と積立金取崩商品の相対的な魅力に対して、金利がどのような影響を与えたのかは関心事項と言えるでしょう。
所得水準は、全般的に上昇しました。しかし、これらの商品がどれほどの価値を提供したかの判断は、適切な代替ベンチマークと比べて、こうした所得水準がどの程度良かったかによります。こうした比較は、興味深いインサイトにつながります。
2022 was a remarkable year for the interest rate markets. Interest rates are a key driver for the cost of providing an income. Now that interest rates have stabilised to some extent (the latest banking crisis aside), it will be interesting to see what impact they have had on the relative attractiveness of the two main retirement income products—annuities and drawdown.
Income levels have gone up across the board. However, how much these products deliver value may also be determined by how well those income levels compare to a suitable alternative benchmark. Such comparison leads to some interesting insights.
Level annuities appear to now offer better value…
Annuities offer retirees a chance to protect against the risk of living longer than expected. This guarantee has a cost to be borne. This expected cost can be offset to some extent by making credit-risky investments, to which there is some restriction through insurer capital rules on how much credit can be taken. There is a balance therefore between cost and benefit to the retiree.
The graphs below illustrate firstly some sample market annuity rates for a “typical” 66-year-old retiree1 on some selected dates, sourced from the Money Advice Service calculator.2 We assume this 66-year-old is expected to live on average to age 88. The alternative in this case is to invest into a static portfolio of gilts that match the cash flows to the expected age of 88—thus without both the longevity protection and the credit yield.
As we can see from Figure 1, annuity rates have as expected risen significantly. Figure 2 illustrates the expected difference between the cash flow yield of an annuity to the expected life expectancy of age 88, compared to the expected yield (on the same pricing date) that could be earned on a portfolio of gilts used to match cash flows to the same age.
In 2022, this expected yield premium was significantly negative—reflecting that the cost of capital to protect a longevity guarantee far outweighed the credit that could be taken for any investment yield above gilts. One year later, and we see the benefit of widening credit spreads pushing this yield premium back to more favourable levels.
… but this value can vary significantly
However, interestingly this increased benefit is highly variable within a short space of time. Figure 2 shows that this yield premium swung quite significantly, from positive in January of this year to negative just one month later.
Figure 1: Comparison of sample market annuity rates
Figure 2: Comparison of expected yield premium over a static gilt portfolio
These results indicate how challenging it can be to ensure you are delivering best value with an annuity to retiring members. When comparing between different dates for taking an annuity, as well as the annuity rate itself, the impact of the investment performance of the underlying fund must be considered as well. However, even allowing for the market downturn in 2022, for those annuitising at the start of last year, if they had waited just one year more, they could now be enjoying a significantly better retirement.
For lifetime drawdown, sustainable income levels are higher, but stable relative to cash
We now come to drawdown. Considering this product in isolation, we assume that drawdown is intended to provide an income for life. A key question is on how to define a sustainable level of income. For a relatively risk-averse retiree, planning for a success probability of 90% for maintaining a desired income whilst alive does not seem an unreasonable confidence level. Some other key assumptions are a 50% equity and 50% bond fund, and a total fee level of 0.40% per annum (p.a.). From these assumptions we have calculated a “sustainable level of income”, on both a level and increasing income basis.
Figure 3 illustrates that sustainable income rates have gone up, comparing results based upon future scenario projections calibrated to market conditions at the end of 2021, with the end of 2022. The famous “4% rule”3 was derived assuming an allowance for a constant annual increase in income each year. Assuming a 2.5% annual increase, it is interesting to see that, at the end of 2021, the sustainable income rate was considered to be less than the 4% rule benchmark, whereas at the end of 2022 it is now well in excess.
Figure 3: Sustainable income rates for a multi-asset drawdown
For sustainable income rates assuming level income, these are slightly less than the corresponding annuity rates from Figure 1 above. This shows that (other factors aside) the expected benefit of participating in a longevity pool with an annuity can outweigh the expected benefit of enhanced investment returns from a multi-asset fund. Given the wide range of potential future returns from a multi-asset fund, a sustainable income rate has to be set at a comparatively low initial level to deliver a lifetime income with sufficient confidence.
Figure 4 then compares the uplift in sustainable income rate from a multi-asset portfolio, compared to running the same calculation with 100% cash or 100% gilts.4 Moving from end-2021 to end-2022, we see that the margin over either cash or gilts has not moved a great deal. There is therefore not much change to the message that it is significantly more optimal investing a drawdown in a diversified multi-asset, than it is in a cash fund, or a pure gilts fund – despite an increase in the expected interest rate you’ll receive on bank deposits, and increased expected yield on gilts.
Figure 4: Uplift in sustainable income rate, comparing multi-asset with cash or gilts drawdown
The case for blended solutions?
There has been much recent talk of the idea of combining both annuity and drawdown, to combine the advantages of each—with two main models, either to partially annuitise at outset, or to defer full annuitisation until later in retirement.
For any model promoting systematic annuitisation at a defined age, exposure arises to a risk that is not obvious—the relative attractiveness of annuity pricing (irrespective of the underlying level of interest rates). This risk is difficult for retirees to assess but can be important given the irreversibility of an annuity purchase. Looking back at the last year, if members had purchased at the end of 2022 instead of the start of 2022, their retirement incomes would have received a boost from more favourable pricing conditions.
We recognise that annuity purchase decisions will be driven by a number of factors and pricing conditions is just one of them. Nevertheless, the presence of this risk alongside variation in the general level of interest rates are important factors for those seeking to secure an element of guaranteed income. Phasing any purchases over a number of years clearly offers scope to mitigate the danger of unfortunate timing.
That said, for all the challenges of systematic annuitisation, if looking from a risk perspective, it is hard to argue against the logic of matching residual essential spending (not covered by the state pension) with an insurer-backed guarantee for life. The key question is how best to deliver optimal lifestyle and discretionary spending, for an optimal retirement?
Figure 5: Balancing for an optimal retirement
The case for dynamic solutions, and flexibility
Given how quickly markets can change, some form of dynamic approach that allows flexibility to adapt to changing conditions and circumstances may potentially work best. As previous research has highlighted we really cannot expect the vast majority of members to be actively engaged in managing their retirement incomes, so minimal decisions with strong (“nudged”) guidance may ultimately be what is most practical.
Step 1: The challenges of timing annuity purchase highlighted above point towards an invested drawdown solution to begin. The first “strong nudge” could be aimed at getting retirees into an investment vehicle that can provide income.
Step 2: Retirees would benefit from professional guidance on what level of income to take initially. As we’ve seen over the past year, the level of income that is considered sustainable can shift significantly and quickly. How can we expect members to judge this appropriately? It would surely be in the consumer interest for providers to give some indication of a sensible/sustainable income level to begin, with the option to change if members so desire. To avoid complications, income may simply be in the form of a divestment into a cash account, where the pace of withdrawals outside of the pension wrapper could be dictated by the retiree—in line with the model currently used by National Employment Savings Trust (NEST).
Step 3: If interest rates rise significantly or investment performance is particularly strong, then information could be provided to allow retirees the benefit of adjusting their incomes (or rates of divestment from growth to cash) to take advantage of the ability to safely take more. In the interest of caution, the ability to increase could be an active member decision.
Step 4: If interest rates fall or investments perform poorly, then warnings could be provided to encourage retirees to reduce their income rates (or rates of divestment from growth to cash). Potentially to act in the best interest of a member, such adjustments could be framed as a default change, but with the opportunity to opt out.
Step 5: As retirees age, the attraction of the longevity protection increases. As we’ve discussed, it is challenging to solve the pricing/timing risk issue of annuity purchase. Theoretically, the concept of longevity pooling does not have to be just via an annuity. At its simplest it involves sacrificing residual assets on death, to receive an income benefit contingent on survival. The decision to simply sacrifice a death benefit, instead of timing a switch into an alternative product, may be a less complex one to help navigate and guide your members. As Collective Defined Contribution (CDC) draws closer, it may therefore ultimately be the route that we go down for decumulation, if we don’t see alternatives come to market.
Conclusion
Rising interest rates have led to higher annuity rates and higher sustainable income drawdown rates. Such sharp changes in annuity rates, as well as the comparative value relative to gilts, highlight the challenges of timing and pricing risk for this product. Although sustainable income rates for drawdown have gone up, given the innate flexibility of this product, retirees are better able to adjust their retirement planning to account for different conditions.
To deal with the rapidly changing markets and unforeseen risks, decumulation frameworks that are flexible and dynamic, where retirees can be appropriately nudged or guided in their choices, might ultimately lead to more resilient outcomes.
1 We assumed a single life level annuity with a five-year guaranteed period, for someone living at post code CV5 6BD, with a £50,000 pension fund value and no adverse health conditions.
2 MoneyHelper. Compare Guaranteed Income Products (annuities). Retrieved 5 April 2023 from https://comparison.moneyhelper.org.uk/en/tools/annuities.
3 Bengen, William P. (October 1994). Determining Withdrawal Rates Using Historical Data. Journal of Financial Planning. Retrieved 5 April 2023 from https://www.retailinvestor.org/pdf/Bengen1.pdf.