Interest rates and life annuity rates: their relationship

Content courtesy of Siba Mgijima from Sanlam.

Firstly, the assets backing our life annuities are mainly bonds. As you probably know, a bond is a fixed income instrument that represents a loan made by an investor to a borrower (typically corporate or government). We make use of longer-term bonds of 20 to 30 years, which coincides with the average lifetime of retirees after retirement.

Bond Prices change in response to interest rates:
Interest rate increases = bond prices decrease (inverse relationship)

Bond Yields are inversely related to bond prices:
The higher the price, the lower the yield and vice versa.

Therefore, an increase in interest rates = an increase in bond yields.

Buying a bond is not the same as buying an annuity, however. While the yields on the underlying bonds are a key factor in setting the interest rate assumption for annuities, there are many factors to take into account when determining the eventual annuity rates. The changes in the bond yield curve can only be used to predict an overall increase or decrease in annuity rate, but the exact quantum will depend on the changes in all the other considerations specific to the determination of the annuity rate itself, i.e. age, gender and other client specifics.

Below is an illustration of the South African 20-year government bond yield over the last year:

What this means is that this may be an even better time to consider making use of guarantees in your investment planning.

If you have any questions or queries regarding any aspects of Life investments, please feel free to reach out to us at ICON, or to your adviser at Sanlam.