On the surface, making every retiree buy an annuity with part of their retirement monies, seems a sound idea. So has this idea any merit beyond making some large life companies happy?
The fact that the UK with a £11 billion plus annuity market, has scrapped compulsory annuity purchases required by age 75, means the issue should be examined more closely. In the UK the annuity rates currently on offer are the lowest they have been for 20 years. A compulsory system needs flexibility to avoid huge dangers associated with a point of time purchases - that lock in poor outcomes for ever.
A compulsory system could disadvantage the disadvantaged. People with health problems or disabilities should not receive the same rate of pension - they should receive more. If this is not done properly, because there is a link between wealth and health, the disadvantaged would subsidise the rich.
Requests by the industry for long duration inflation linked bonds and longevity products underwritten by the government, effectively pushes the adverse risks for people with money to the government. The government already underwrites a fair amount of this risk via the Age Pension. There may be a case to allow up to (say) twice times the Age Pension to be purchased. Beyond that level it is difficult to see the case to underwrite this section of the community in a position best able to operate under market discipline. Otherwise a danger exists that the implicit guarantees will be exploited.
Compulsory annuities may not suit individual circumstances and requirements, they tend to offer too little income in the early active years of retirement and relatively too much in the frail years. Less income in the frail years is required because Australia does not have the same health cost issues of for example the USA. The retiree is also exposed to the institution not failing for a 20-40 year period and the adage of "too large to fail" rings false post GFC. Indeed the purchase is likely to be from that organisation offering the highest annuity rate and hence with the lowest profit margins.
There is a place for immediate, deferred and flexible annuities. However, compulsory purchase requirements could generate more problems than they would solve.
The NetActuary Team