This article was first published in the Fourth-Quarter 2013 Edition of Personal Finance Magazine.
Last year, a women, Ms X, with stage-four cancer, approached life company Paramount Life and asked what annuity (pension) it would give her for R1 million.
The answer was an astounding R930 000 a year, or R77 500 a month. This was equivalent to 93 percent of her original capital.
If Ms X had approached any other life assurer, she would have received about R8 000 a month. This would not have been nearly sufficient to cover the expensive medical treatment she required. In addition, she would have lost her remaining capital if, as expected, she died soon after receiving the pension.
Jason Sharp, chief executive of Paramount Life, says that, by analysing Ms X’s circumstances, Paramount Life was able to accurately identify her expected lifespan. This meant that her income was enhanced to a level that would be unthinkable in the standard market.
- This ensured that the financial burden of her medical treatment did not fall onto her daughter, who could not have afforded the necessary treatments. Ms X was able to protect herself and her family from financial distress in the short term, as well as in the long term, if she recovered,” Sharp says. He says Ms X received the equivalent of her full capital by the time she died about 12 months later.
What Ms X had done was to buy what is called an enhanced annuity or, in an apparent contradiction, an “impaired” annuity.
The big advantage of these annuities is that you get a much fairer deal if you are in bad health than you would if you bought an ordinary guaranteed pension. This is specifically the case if you are a smoker, are in a sub-par financial situation, have a history of poor health, or your health is currently poor.
Traditional Guaranteed Pensions are normally calculated on Three Factors:
- Expected long-term interest rates, because the underlying investments for most annuities are interest-earning assets, such as bonds. The higher the prevailing interest rates, the more you receive.
- Your age, because the older you are, the shorter your lifespan is expected to be, on average.
- Your gender, because women live longer than men, on average.
What is not taken into account is your state of health or lifestyle.
For some years, National Treasury has been voicing its concern about the limited number of factors that life assurance companies take into account when selling guaranteed annuities. Its concern is that people with worse-than-average lifestyles and the unhealthy are subsidising the better-off because they are expected to live longer.
On average, the rich and better-educated live longer than the poor and less well-educated. This is because the wealthy can afford a healthier lifestyle and have access to superior health care. For the same price, a wealthy pensioner, on average, will receive a pension for many more years than a low-income pensioner. So the low earners subsidise the rich.
What is even more unfair is that people with shorter life expectancies who buy assurance against death pay more than those who are expected to live longer. If you are suffering from a heart condition, smoke or dive for deep-sea diamonds for a living, you will pay a higher premium for the same amount of cover than, say, a healthy accountant.
Yet, when it comes to buying a pension, most life assurance companies take into account only the three factors of interest rates, age and gender.
Enhanced annuities, which take more than these three factors into account, have been around for many years, but they never really caught on in South Africa. Sharp says this is because the products in the past did not provide guarantees for the enhancement – in other words, if you recovered from your medical condition, your annuity would decrease.
(By Bruce Cameron)