A world where animal spirits are running wild is also one that has temporarily divorced from fundamentals. Experience tells us this often doesn’t end well.Â
The wealth transfer from Baby Boomers to their offspring, which is in full swing, has got the taxman’s full attention, especially as it pertains to capital gains payments, trust structures and potential breaches of the Tax Act’s Division 7A.
Lifetime annuities: catastrophes waiting to happen
New research has cast doubt over the sustainability of the lifetime annuity business through the study of the holistic risk of issuing lifetime annuities from the insurer’s perspective. The researchers recommend the establishment of national catastrophe schemes in the markets where lifetime annuities are written – which is most developed markets.
The researchers are: John Evans, a former asset consultant and guardian of the NZ Superannuation Fund who is now associate professor of the Australian School of Business at the University of NSW; Amanda Ganegoda, who is manager of operational risk at ANZ Bank; and Toby Razeed, a lecturer in accounting at the University of Sydney.
The two major risks that issuers of lifetime annuities face are significant changes in asset prices and significant shifts in mortality. Financial returns are not normally distributed and their marginal distributions are characterized by heavy tails and asymmetry. Extreme volatility tends to be introduced in the modeling as “random shocks”. Mortality does not have the same volatility as capital markets but it does exhibit significant changes over time, namely, with life expectancies rising sharply in developed countries over the past 30 years.
The researchers define the two major risks as “Knightian uncertain” risks, which means they can be identifies but not quantified with any degree of certainty. They are threats to survival, of the issuer, as it is not possible to ascertain the appropriate capital to manage the risks.
Because lifetime annuities typically span several decades the issuers are also exposed to “ignorance risks” because there could be unpredictable changes in regulatory, legal, technological and social landscape that could make a material difference to profits.
They conclude: “A national catastrophe scheme, partly funded, would seem the only satisfactory solution to ensure an efficient development of the lifetime annuity market that is necessary for economic stability in most developed economies”.
In Australia, most annuities issuers have exited the market. The two main ones left are CommInsure and Challenger.
