Give retirees the choice of variable annuities to hedge against inflation

My friend Prakash, a fitness enthusiast, exercised daily —running, weightlifting, and stretching. At 60, his doctor advised him to slow down, recommending leisurely walks instead. Prakash resisted, questioning: “After all, age is just a number, isn’t it?”

 

He drew an analogy between this and India’s annuity market. Annuities, offered by life insurance (LI) companies, provide periodic pension payouts in exchange for a lump-sum premium. India’s stagnant annuity market gained attention after the finance minister proposed a regulatory coordination forum to develop it.

 

Prakash, now 60, built a retirement corpus of ₹1 crore through the National Pension System (NPS). He withdrew 60 per cent tax-free, leaving ₹40 lakh for an annuity. LI companies offered him only “guaranteed” lifetime payouts. Even if he chooses an annuity without a return of corpus, he would get ₹30,000 per month fixed for life. The catch — his initial investment of ₹40 lakh will not be returned even if he dies immediately after taking the annuity. If he opts for a return of corpus to his nominee, the pension payout drops to ₹22,000 per month, yielding around 6.75 per cent annually. The issue? These fixed-for-life pension payouts are offered by LI companies by investing the premium in “safe” but low-yielding government bonds. The pension will not keep pace with inflation. If inflation averages 6 per cent annually, his ₹22,000 pension would be equal to ₹5,000 in today’s purchasing power—making it insufficient.

 

Prakash is willing to take a risk to get inflation-adjusted returns, but no option is available to him. Despite building the corpus through his calculated risk-based NPS investment, he is now being forced into a low-return “guaranteed” structure — akin to being barred from exercising just because he turned 60.

 

His concern is valid. A 50:50 equity-government securities NPS portfolio has averaged 10 per cent annual return over the past decade. If his ₹40 lakh corpus earns the same, he could start with ₹22,000 monthly, adjusted for 6 per cent inflation, reaching ₹89,000 monthly at age 85 —while preserving the corpus for nominees for the first 20 years. While this is a simplistic projection assuming a stable return of 10 per cent every year, better risk-adjusted models exist that take variations into account, including periods of negative return. As long as the word “guaranteed” is not part of the equation, the numbers may not change much.

 

Globally, in countries like the United States of America (USA), Canada, Australia, and across Europe, pension markets offer a range of Pension Payout Products (PPP) — fully variable, partly fixed, or completely fixed (like India’s). The key difference? Choice is available to investors, and it is they who choose whether to take the risk or not.

 

LI companies haven’t launched variable PPPs despite no regulatory barriers. The mutual fund industry has a demonstrated track record of selling risk-based products responsibly without underplaying the risk. Mutual funds should be allowed to offer PPPs as a separate line of business, just like the proposed specialised investment funds.

 

Truth be told, the government can also benefit from a successful variable PPP. If private-sector employees adopt it, government employees could follow. The Unified Pension Scheme (UPS) ensures a minimum pension payout for every government employee. After-retirement, this individual retirement corpus is transferred into a common pool for the payment of fixed pensions. A viable private-sector variable PPP could ease the pressure on this common pool, ensuring sustainability.

 

Retirees aren’t children in need of overprotection. They deserve the choice of variable PPPs to hedge against inflation in retirement that could sometimes last as long as their working years. Let’s hope they are given that choice, even as those who need it continue to have access to the existing fully guaranteed plan.

 

Disclosure: As a Securities and Exchange Board of India (Sebi)-registered investment advisory firm, the author’s firm recommends investments in mutual fund schemes for its clients and thus can be said to be interested in the mutual fund industry.

 

The writer heads Fee-Only Investment Advisors LLP, a Sebi-registered investment advisor; X: @harshroongta