7.3 Long-term saving (continued)
7.3.5 Annuities
Box 8: Why is the annuities market underdeveloped?
New Zealand is not alone in having an underdeveloped annuities market. There are supply and demand reasons for the general lack of availability of annuities:
Supply constraints:
- Pricing – The relatively small number of people who buy annuities and the lack of actuarial data on annuitants’ life expectancy makes pricing difficult for providers. This is especially the case in a small country such as New Zealand. Furthermore, people interested in buying annuities do so because they are healthy and thus confident that they will receive the annuity for a long time (the adverse selection problem resulting in annuitants tending to live longer than the population in general).
- Matching assets – Annuity providers have difficulty finding suitable assets, such as long-term government bonds, to match the structure of their annuity liabilities and there are few instruments enabling them to hedge longevity risk.
Demand constraints
- Complexity of products – the attractiveness of annuities is reduced by the risk of inflation eroding fixed annuity payments, their illiquidity and often a lack of transparency in their pricing.
- Lack of flexibility – there is generally little room for annuities to change when circumstances change.
- Lack of understanding – many consumers lack understanding of the nature of annuity products.
- Other pension schemes and social assistance – the provision of inflation-protected, wage-adjusted pensions such as NZ Superannuation as well as social assistance, such as health care, is likely to reduce the demand for annuities. In effect, New Zealanders already receive an annuity income in the form of NZ Superannuation.
- Taxation – the tax treatment of annuities is a potential impediment to the uptake of annuities.[26]
In the course of its discussions, the SWG identified an area of concern relating to KiwiSaver members and others retiring with considerable lump sums, and limited options available to readily convert some or all of such payments into a future income stream. New Zealanders do enjoy a degree of annuitised income in the form of NZ Superannuation. However, we are talking here about a secure income stream in addition to NZ Superannuation.
As it stands, most investors receiving large lump sums early in their retirement (as will increasingly be the case for members of KiwiSaver) will face investment decisions involving larger sums than they have ever seen in their lives. These are complicated decisions on how to best manage their retirement nest-eggs. The SWG is not only concerned with the limited options but also the consequent risk that many will not be able to manage their retirement nest-eggs in their best interests, let alone recognise their vulnerability to bad advice, and the temptation to partly solve the problem by going on a spending spree.
The SWG considers that the situation would be improved if investors receiving such amounts at least had the option of converting some or all of their KiwSaver payout into future income. That is something that the government should consider providing - whether in the form of an annuity, or providing the ability for members to buy an increased entitlement to NZ Superannuation. The SWG notes that while the latter offers a convenient delivery mechanism in a well-understood context, it would be necessary for any extra NZ Superannuation entitlements acquired in this way to be contractually based (and thus immune from any changes that future governments may make to the underlying standard NZ Superannuation entitlements). The SWG also recommends that consideration be given to whether members of KiwiSaver should, in time, be required to take some portion of their withdrawal in the form of such an annuity/NZ Superannuation increase (rather than as a lump sum).
Any government involvement should be on a full cost recovery basis, and might involve encouraging private sector annuity providers.
While the lack of a material annuities market in New Zealand is a current shortcoming for anyone receiving lump sum retirements payments from their superannuation schemes, the SWG recognises that in relation to KiwiSaver this issue does not become acute for another five or so years - as it will not be until then that many will be receiving material amounts upon their retirement. However it recommends that planning commence now. The first retirement withdrawals from KiwiSaver will take place in mid-2012, and at least a small proportion of those members will have sizable lump sums.
7.3.6 Other long-term saving
The SWG has a general concern with the lack of long-term savings opportunities for New Zealanders (outside of locked-in retirement-based schemes). One aspect of this is whether national saving can be increased over time by extending KiwiSaver-style incentives to saving schemes where contributions are locked-in for reasonably long periods, say, a minimum of 10 years (which would be attractive to those younger investors who might be deterred by having their savings locked-in until retirement). Another aspect is providing more appropriate choices for those who are already retired and looking for options to invest lump-sum receipts.
Aside from potentially extending the KiwiSaver incentives, the SWG would like to see the government consider facilitating long-term investment by issuing inflation-indexed bonds as well as annuities, as suggested above.
7.3.7 Declining home ownership
Paying off a mortgage has long been a way for New Zealand households to save. Repayments of principal reduce debt, and hence are a component of household saving. Most owner-occupiers with mortgages would be repaying the principal as part of their regular payments to the mortgage lender.
However, it seems that this avenue of saving is on the decline, owing to a decline in home ownership. The decline in ownership has been steady since 1991, even after adjusting for the increasing use of family trusts. In 1991, 73.8% of households owned their own homes according to the census in that year. But by June 2010 the ownership rate was down at 64.8%, according to the Household Economic Survey. Explaining this decline is not straightforward. But the main factor behind this is likely to be the long-term rise in the level of house prices relative to household disposable income. Influences on the rise in this ratio include: greater interest by small investors in owning rental property; rises in land prices; financial deregulation, which has increased access to housing finance to residential landlords; high immigration; and the tax-favoured treatment of housing.
Most housing analysts expect home ownership to keep declining in New Zealand (see for example DTZ New Zealand (2007)), which will mean that an even smaller proportion of the population – and especially people in younger age groups – will have the opportunity of using home ownership as a saving strategy.
This highlights the need to ensure that other suitable forms of investment – like well-managed superannuation schemes – are available as vehicles for long-term saving.
Notes
- [26]Investment income is taxed at the company tax rate, which is higher than the purchaser's marginal tax rate for individuals earning less than $48,000.
