The history of annuities and retirement income products.
From ancient Egypt to present day, the journey of retirement income reflects humanity’s enduring quest to secure financial stability in later life. Each era has brought new ideas, products, and systems driven by changing societal needs, economic conditions, and technological advancements. This constant innovation not only showcases the financial industry’s adaptability but also its crucial role in addressing one of life’s most fundamental concerns: how to maintain quality of life when our working years are behind us.
By learning from the time-tested principles of annuities, and combining this knowledge with the strengths of our superannuation system, Australia has the opportunity to create a world-leading retirement income system. A system that provides secure, flexible, and sustainable income streams and allows retirees to maintain their dignity and quality of life throughout their retirement years.
Let’s start at the very beginning.
Ancient Beginnings
Archaeological evidence suggests that annuities were used in ancient Egypt between 1100 and 1700 BCE. This evidence shows that Hepd’efal, a prince ruling in Sint during the Middle Empire, purchased what archaeologists believe to be one of the first recorded annuities. The Egyptian origins of annuities contributed to a financial concept that has endured for thousands of years, evolving and adapting to meet the needs of different societies throughout history.
While annuities have roots in ancient Egypt, they gained greater popularity in the Roman Empire. Citizens entered into contracts called “annua”, annual stipends paid to Roman citizens. These early annuities were often used to settle legal disputes or provide for dependents, laying the groundwork for the idea of guaranteed income streams. Roman soldiers also received a form of annuity as compensation for their military service, paid out as annual stipends.
In the third century CE, the Roman jurist Ulpian created the first known life table, which experts suggest provides a rough outline of ancient Roman life expectancy and was possibly used to price annua.
Medieval Innovations
During the Middle Ages, annuities evolved as a financial instrument for governments to raise funds. This practice spread across Europe, with governments and religious institutions issuing annuities to finance wars, public works, and other endeavours. While far removed from modern superannuation, these developments established the principle of exchanging current capital for future income—a concept at the heart of today’s retirement planning.
The Renaissance, Tontines and the Birth of Actuarial Science
The 17th century saw the introduction of a new financial product, the tontine, designed by Lorenzo de Tonti, an Italian living in France. The French Government, under King Louis XIV, issued the first national tontine in 1670, and the English Government, under King William III, followed suit in 1693.
These early tontines primarily aimed to raise capital for the state. They were seen as an alternative to traditional government bonds or taxes, offering a way to attract investors and generate funds for the royal treasury. The issuance of these early tontines by national governments marked a significant innovation in public finance and retirement planning.
Initially, tontines, while innovative, lacked scientific pricing. The Renaissance brought scientific rigour to annuity calculations. In 1671, Dutch mathematician Johan de Witt published Value of Life Annuities in Proportion to Redeemable Annuities, laying the foundation for modern actuarial science. De Witt developed a method for calculating the present value of annuities based on mortality rates. In 1725, Abraham de Moivre published Annuities upon Lives, based on the mortality statistics gathered by Edmund Halley in the 1690s. De Moivre produced a simple formula for approximating the revenue produced by annual payments based on a person’s age.
US Treasury Secretary Alexander Hamilton proposed using tontines to reduce the national debt. The proposal was ignored by Congress, and Lin-Manuel Miranda missed a great opportunity to include a musical number about tontines in his hit musical. Imagine the drama it could have added to the performance!
As tontines gained popularity, these early actuarial insights began to inform their design and pricing. In 1746, Antoine DeParcieux used data from tontines, individual families, and religious communities to write a treatise on annuities and mortality, Essai sur les probabilités de la durée de la vie humaine (Essay on the probabilities of the duration of human life). The work of these proto-actuaries was crucial in developing the mathematical models that underpin today’s retirement income products, allowing for more accurate pricing and risk assessment.
Industrial Revolution and the Rise of Mass Market Annuities
The Industrial Revolution marked a turning point in retirement planning. As life expectancy increased and a middle class emerged, the demand for financial security in retirement grew. Insurance companies began offering annuities to the general public, with the Presbyterian Ministers’ Fund in the United States selling the first commercial annuity in 1759.
Throughout the 18th century, pastors were often the first Americans to receive annuities, funded by donations from their congregations. Benjamin Franklin famously left annuities to Boston and Philadelphia in his will, which continued paying out for over 200 years.
By the late 19th century, annuities were a common financial product offered by insurance companies across the Western world.
In the US, a particular form emerged with the launch of a life-insurance style tontine in 1868 by Equitable Life. It was the brainchild of the company’s founder, Henry B. Hyde, who was reported saying the “risk of living too long is just as insurable and valuable as the risk of dying prematurely.”
The product was too successful and resulted in large amounts of money sitting with poorly regulated life insurance companies for long periods of time—a recipe for corruption and misconduct. Following the 1905 Armstrong Commission in New York, the state banned the product, and other states soon followed suit.
20th Century Innovations
The 20th century saw rapid innovations in retirement income products commencing in 1912 when the Pennsylvania Company for Insurance on Lives and Granting Annuities became the first American company to offer annuities to the general public. Annuities gained popularity during the Great Depression of the 1930s, as people sought financial security and stable institutions.
A significant milestone in the development of retirement income products occurred in July 1952 when TIAA introduced the world’s first variable annuity. This product allowed investors to participate in market gains while still providing guaranteed income. It inspired David Orford to create Optimum Pensions and design the Real Lifetime Annuity, now offered by Generation Life as LifeIncome.
Indexed annuities, first offered in 1995, linked returns to stock market indices while offering downside protection. These innovations expanded the range of options available to retirees, balancing the need for security with the desire for growth.
The Future of Retirement Income in Australia
It has been more than 30 years since the introduction of compulsory superannuation in Australia, and we are still trying to solve what Nobel Laureate William Sharpe described as the “nastiest, hardest” problem in finance – effectively and efficiently converting retirement savings to retirement income.
Many retirees struggle to manage their superannuation savings effectively throughout retirement, facing risks such as outliving their savings or experiencing significant market downturns. In a recent interview, Jennifer McSpadden, Brighter Super’s head of retirement, said, “If retirees feel secure and know what income they can expect, this can provide them with more confidence and potentially decrease the tendency to underspend.”
This has led to renewed interest in retirement income solutions within the superannuation framework. In December 2023, the Australian Government released a discussion paper seeking community and industry views on how the superannuation system can best provide the security and income Australians need as they live longer and healthier lives in retirement.
As Australia looks to the future, the debate around suitable retirement income products intensifies. Given the diversity of retirees ‘ needs and circumstances, there’s growing recognition that a one-size-fits-all approach is inadequate. This has spurred innovation in retirement income products, including group self-annuities and investment-linked annuities.
These products aim to balance the desire for flexibility and potential market upside with the need for secure, lifelong income. They draw on centuries of annuity development while adapting to the unique structure of Australia’s superannuation system.
Global Lessons for an Australian Context
As Australia refines its approach to retirement income, similar trends are occurring around the globe with the emergence of variations of “Modern Tontines”, which Richard Fullmer defines as “an innovative product that allows individuals to share longevity risks in an actuarially fair and transparent manner”.
Moshe Milevsky explains the fundamental principle in his book, “How to Build a Modern Tontine: Algorithms, Scripts and Tips”, in that they “enhance the investment rate of return by harvesting mortality credits from those investors who predecease them.”
The use of mortality credits is a key feature in Australia’s innovative retirement income solutions and those being developed elsewhere.
Conclusion: Bridging Ancient Wisdom with Future Innovations
The history of retirement income solutions, from Ancient Egypt to Roman annua to modern superannuation products, reflects an enduring human need for financial security in later life. As Australia grapples with the challenge of providing adequate retirement incomes for an aging population, it stands at the intersection of this rich history and an innovative future.
The key lies in learning from historical successes and failures while embracing new technologies and evolving societal needs so Australian retirees can live their best life throughout their retirement years.
As the debate continues, one thing is clear: the future of retirement income in Australia will be shaped by our ability to honour the wisdom of the past while boldly embracing the possibilities of the future.
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Authors: David Orford & Stephen Huppert