Consumer understanding key to risk pooling
Investors need to carefully choose annuities and other types of risk pooling products, according to new research from Lonsec Research and Milliman.
Referencing the increased focus on under-insurance generated by the debate around the Life Insurance Framework (LIF) the research analysis said that while pooled mortality products came in varying degrees of sophistication and complexity, the two main factors affecting value for individual investors were product design and life expectancy.
"With Australians living longer, investors must have a clear understanding of the product to ensure it is suitable for them," it said.
"For those unfortunate enough to die early, a simple annuity product offers a very poor investment return as all capital is lost on death, and this loss is used to cross-subsidise those who live longer."
It said that, likewise, a contract design with 100 per cent death benefits provided for a more significant benefit payable to those who died or surrendered their contract early, but it also significantly reduced the mortality credits receivable by those who lived longer.
The research analysis said that, given the debate surrounding the proposed LIF legislation, there had been renewed focus on consumers' understanding of life insurance and related products, as well as the fear of underinsurance.
"While underinsurance is a valid fear, investors also need to ensure that the insurance they choose is appropriate for them and their life circumstances," it said.
According to Lonsec Research, while mortality credits can be an effective means of mitigating longevity risk and avoiding underinsurance, it is essential that the investor feels comfortable with the product structure and understands the trade-offs involved.
"Mortality credits are an innovative way of dealing with longevity risk, or the risk of running out of income before you die," Lonsec senior investment consultant, Eleanor Menniti said.
"But you need to understand how the mortality credits are generated and what assumptions are being made."
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