Edition: Dec 2013- Feb 2014

Introducing the Sanlam Employee Benefits Inflation Annuity tracker

A product whose time has come, suggests Sanlam Employee Benefits head of guaranteed investments Danie van Zyl.

Van Zyl...liability focus

Fund members often approach retirement savings with the goal of saving a certain rand amount by the time they retire. The flaw in this approach is that it ignores what is really important, namely an inflation-linked annuity income for the rest of a member’s life.

This is where interest rates come into the picture. They have a major impact on the cost of a guaranteed annuity. If the interest rate used in calculating an annuity income for life reduces by 1%, it can lead to a reduction in your initial income of 10%. A major risk is that members do not know what interest rates will be at retirement.

The Sanlam Employee Benefits Inflation Annuity Tracker tracks changes in the relative cost of an inflation-linked annuity caused by changes in interest rates. Members who are within five years of retirement can therefore aim to preserve their ability to afford an inflation-linked annuity.

Alignment with retirement reform

As part of the bigger retirement-reform discussions, National Treasury has called for retirement funds to put in place a default annuity strategy for their members. It will assist members with the difficult task of converting their defined-contribution lump sum into an income for retirement. This will go a long way to address some issues raised in our 2013 Sanlam Benchmark Survey; namely that 76% of principal officers are concerned with how members use their retirement savings when they retire, but only 24% of them want any further involvement with members after retirement.

From our Benchmark Survey, we also find that principal officers believe that an inflation-linked annuity is the most appropriate annuity choice for their average member. This is an annuity that is paid for however long a member and his/her spouse lives and provides increases guaranteed to equal inflation.

Investment objective

The Inflation Annuity Tracker portfolio aims to closely match movements in its benchmark index, the SALI Real. This index tracks the changes in the cost of an inflation-linked annuity caused by changes in real interest rates. The portfolio therefore aims to preserve a member’s ability to purchase an inflation-linked annuity.

Portfolio benchmark - SALI Real

SALI stands for Sanlam Asset Liability Index. In the same way that the All Share Index (ALSI) tracks the change in value of the stocks on the JSE over time, so SALI tracks changes in the cost of purchasing an annuity.

Real refers to inflation-linked. Members, who want to maintain their standard of living in retirement, should consider buying an annuity that protects them against increases in the cost of living i.e. inflation. An inflation-linked annuity is guaranteed to provide increases equal to inflation.

The SALI Real has been developed by Sanlam to track the cost of purchasing an inflation linked annuity. As real interest rates move up (and down) and the cost of an inflation-linked annuity decreases (or increases), so the index will change to reflect this change in cost.

Who should invest?

  • Retirement fund members, within five years of retirement, who want greater certainty regarding their final retirement income (and wish to link their income to inflation);
  • Defined-benefit pension funds that want to reduce uncertainty in the cost of purchasing a post-retirement income, which grows with inflation, for members close to retirement.

Liability-driven vs Asset-driven investing

An asset-based approach will generally focus on investing in low-risk assets (like cash) to preserve capital close to retirement. This can actually increase the risk of not being able to secure the post-retirement income required. The actual cost of the post-retirement income (liability) is determined by the impact of fluctuations in longer-term interest rates, rather than short-term rates on cash.

A liability-driven approach focuses on the cost of providing the annuity cash flows after retirement and on the factors affecting the cost e.g. interest rate changes. The solution is then to invest in a portfolio of assets that closely matches a member’s expected annuity liability.

For example, a year ago a given retirement nest egg may have been able to purchase an income of, say, R1 000 per month increasing annually with inflation.

An asset-based strategy would report on the returns generated relative to the rand amount at the start of the period, without any focus on the whether it can still purchase the same level of income.

A liability-driven strategy would still report on the returns generated, but the focus would be on ensuring that members should, on average, receive sufficient income to buy the same goods and services they could a year ago with the R1 000. The objective is not focused on guaranteeing capital, but rather on maintaining the level of inflation-adjusted income that can be purchased.

Sanlam Asset Liability solutions

The SALI range of indices forms part of Sanlam’s suite of Asset Liability solutions. They help trustees and members to develop a better understanding of the factors that influence a member’s ability to retire comfortably.

SALI also gives the members access to instruments that help protect the level of monthly pension they hope to receive at retirement.

Equipped with these new insights and products, a member will be able to make better investment decisions. Most importantly, these decisions will be aligned with the pension a member aims to buy at retirement.