Sunday, December 25, 2011

Australian Annuity - Collective Failure To Respond

Australian Annuity

There are a number of reasons why the Australian life insurance and annuity markets have not penetrated the retail customer base more effectively. These include 

  • inadequate product offerings, 
  • perceived attractiveness of alternatives, 
  • insufficient consumer education, and 
  • a laissez-faire government approach.

Inadequate Product Offerings

The current range of available products contains a number of gaps and does not satisfy the demands of both the retail and wholesale markets. In the annuity market there are very few products structured attractively to capture and manage the outflows from the superannuation industry. Currently, the market is split approximately evenly between term and residual capital value products. For example, very few lifetime annuity products are available.
There are also few integrated savings and risk mitigation products covering a number of risks for example, longevity risk, market risk, and healthcare expense risk. As has been outlined, the past three decades have seen a disaggregation of the savings and risk management components of insurance products. This has made the products more accessible to consumers, but this simplistic disaggregation seems to have missed the opportunity to satisfy certain needs. For example, we believe that there is a demand for risk-management products - especially in retirement - that incorporate savings components to satisfy motives such as bequeathal among retirees.
Many retail risk-mitigation products are also not offered at attractive prices. This is primarily due to wholesale methods for managing risk. Longevity-linked products are a case in point, with some insurers declining to offer them at a competitive price as they see the risk as "toxic." These products will become increasingly attractive to both insurers and consumers when wholesale methods are available to transfer the risk, reducing the capital strain on insurers. Australian Annuity
Perceived Attractiveness of Alternatives
A range of attractive alternatives to life insurance products has been available in the investment markets. In particular, pure savings funds have, with the exception of the financial year just ended, enjoyed excellent returns over the past 14 years as a result of strong equity markets. These vehicles are also relatively simple and provide greater consumer control over where their funds are invested than risk-only insurance products. As a result, many consumers have chosen to manage their financial health through conscientious saving rather than investing in risk-management products, consciously or unconsciously ignoring the shortcomings of this approach.
Insufficient Consumer Education 

In keeping with the laconic "she'll be right mate" national persona, more than half the Australian population believe they "do not need insurance" and approximately half regard it as a "waste of money.'' Closely linked to this is the extreme optimism of Australians about remaining healthy. Despite this optimism, Australians have also neglected the risk that they will outlive their retirement savings, as seen in the US$6 billion of annuity sales in 2007, compared to superannuation outflows of US$56 billion.
Australians are also confused about how and when it is appropriate to purchase life insurance within a superannuation product wrapper. Currently, there are tax incentives in place which allow for life insurance premiums (under certain conditions and with some limits) to be paid from pretax dollars. However, superannuation trustees and administrators cannot legally offer advice. This, coupled with a tendency to avoid seeking financial advice and the problems of dual coverage, has led to investor confusion.
Efforts to improve consumer awareness and education have largely failed to hit the mark. Forty percent of Australians use no information to assist in their financial decision making and 56 percent of respondents said they felt they needed further education or information about financial matters. The top two sources of financial advice for Australians are family and friends, and accountants. This has made Australians, relative to their mature market, less advanced in their understanding of financial matters. In a recent OECD survey, 67 percent of Australian respondents indicated that they understood the concept of compound interest, yet when they were asked to solve a problem using the concept only 28 percent had a good level of understanding.
Laissez-faire Government Approach
Finally, the government took an arm's-length approach in supporting the development of a private infrastructure for managing consumers' risk exposures. While the UK has made the purchase of life annuity products by retirees compulsory, Australia does not provide tax incentives for the products. In the 2006-07 federal budget, tax incentives for taking superannuation benefits as an annuity stream were removed. This was done by reducing all superannuauon outflow taxes, which effectively equates the treatment of annuity and lump-sum benefits. 

Furthermore, default life insurance coverage levels within superannuation funds are extremely low. The standard level of coverage is two to three times income while recommended standards are up to 10 times. Surprisingly in Australia - a country with one of the world's most advanced retirement savings systems - post-retirement, risk-management policy and infrastructure are lagging behind significantly. Australian Annuity

Opportunities Ahead

The nature of the opportunities for domestic incumbents and foreign entrants is markedly different in Australia to the rest of the Asia-Pacific region. Domestic incumbents must influence government and educate consumers to create and capture significant value from the management of savings, as well as retirement, morbidity, and longevity risks. In addition, there are a range of distribution, product, and cost innovations available to improve the attractiveness of the industry for participants. 

For foreign entrants, a pure-play, life insurance entry strategy seems unlikely to be financially attractive. A combination of a life and wealth play - focused on combining savings and risk-management skills - to meet the needs of the Australian "wealth builder" could be one attractive option. However, the Australian wealth-management market is extremely sophisticated and well-populated with few assets likely to be for sale. For example, with a few exceptions, most wealth-management franchises are core to the major Australian banks and unlikely to come up for sale.
Domestic Incumbents
We believe players already in the market should focus on two central issues 
(i) reshaping the industry through influendng regulators and educating consumers; and 
(ii) innovating in distribution, product, and cost management.
Reshaping the Industry Through Influencing Regulators and Educating Consumers 
Government intervention is the most direct way of rejuvenating the current life insurance and retirement savings industry. Given the impact of government regulation on the current life insurance and retirement savings industry any significant change to the industry, will require government intervention to amend the relative incentives and benefits of different products. This intervention can be explicit, through providing incentives and tax concessions for investing in risk-transfer products; or implicit, through encouraging consumer education programs and rewarding innovation with supportive regulation. 

Achieving this requires the education of government bodies on the enormity of the latent risks already in the system, the advantage of private risk-management schemes, and the need to develop legislative support and tax concessiom for these products. To make this happen, we believe that the life insurance industry in Australia needs to become more effective at creating industry-level lobbying. By comparison, the superannuation players have worked relatively effectively at an industry level.
In addition, consumer education is required on the level of risk exposures and the types of products available. For example, retirees need to be convinced that life annuities are not simply a "gamble" on their own life expectancy where they may see life savings forfeited to insurance companies. Rather, they must be shown that by using life annuities to manage their retirement savings, based on expected rather than maximum lifetimes, their yearly pension income can be substantially increased, improving their quality of life.

Next, we'll talk about innovating in distribution, product and cost management. At mean time, you can check out Australian Annuity for more details.

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