【QDAP】Despite disclosing their internal rate of return, tax-deductible annuities still have blind spots that cannot be ignored.

Many consumers rushed to take out qualifying deferred annuity policies (QDAPs) before the tax season in order to enjoy tax benefits. After the tax season, people may no longer be as eager to purchase annuities. However, in view of the COVID-19 pandemic, Hong Kong people have been strictly observing social-distancing measures, causing insurance sales to suffer a significant blow. QDAPs are one of the few products exempt from financial needs analysis and allow insurance intermediaries to complete sales without meeting clients in person. As a result, tax-deductible annuities remain a key focus of insurers’ sales this quarter. A policy is only recognised as a qualifying deferred annuity policy if it meets the requirements of the Insurance Authority. However, even if a QDAP is certified by the Authority, this does not necessarily mean that it offers high returns or is suitable for you. When comparing products, you still need to remain vigilant to avoid falling into the traps of deferred annuities.

QDAPs must comply with the Insurance Authority’s guidelines (see Note 1) for their premiums to be tax-deductible. These guidelines ensure that the products are deferred annuities, enabling policyholders to save money and receive annuity income for at least 10 years after the age of 50. In terms of disclosure, unlike ordinary whole-of-life savings insurance, which generally does not disclose the internal rate of return and instead focuses on the expected total return, QDAPs are required to disclose the internal rate of return (IRR):

• The guaranteed IRR and total IRR should be presented as the highest and lowest IRRs respectively;
• The IRR should be illustrated using the example of a 45-year-old non-smoking male policyholder.

The purpose of the above guidelines is to disclose the returns of QDAPs, making it easier for customers to assess them. However, from a consumer’s perspective, a careful review of the product brochures of major insurers reveals that comparing QDAPs remains extremely difficult, with pitfalls everywhere…

Blind spot 1: Insurers use different formats — no standardised format for qualifying deferred annuity policies

Although the Insurance Authority requires insurers to disclose the IRR at policy maturity of a QDAP based on the example of a 45-year-old non-smoking man, it has not prescribed a standard format or terminology. Insurers therefore present the IRRs of different options in their own ways.

• Some products explain their IRRs using different “premium payment periods” and “ages at commencement of annuity payments”; others list their IRRs according to the “premium payment period” and “accumulation period”. For the latter, consumers have to calculate for themselves when the annuity payments begin. (So, when exactly does the “accumulation period” start — when the first premium is paid or when all premiums have been paid? Would the average consumer know?);
• Some products’ IRR tables do not specify the “annuity period”. Consumers therefore have to scrutinise the product brochure and look elsewhere to find the annuity period, in order to avoid making an apple-to-orange comparison;

Blind spot 2: Falling into the IRR myth — is a high IRR a guaranteed win?

IRR is an important indicator of the returns of a deferred annuity. Many consumers believe that they only need to select the option with the highest IRR shown in the product brochure. But is there really no problem with simply choosing the highest figure? Referring to the chart above, let us look at the highest (max) and lowest (min) IRRs among the guaranteed IRR ranges of the respective products:

The highest and lowest guaranteed IRRs disclosed in the product brochures of the following products

Assume that the policyholder is a 45-year-old non-smoking male. The policy currency is US dollars.

The above information is extracted from the product brochures of the relevant products. Updated on 22 April 2020.

Among the highest (Max) guaranteed IRRs of the above QDAPs, Prudential’s 1.86% ranks first, followed by Manulife’s 1.74% and AIA’s 1.72%. At first glance, Prudential’s 1.86% is the highest of the three. Its premium payment period is five years, annuity payments begin at age 70 and continue for 20 years, and its total policy term is 45 years, giving it the longest accumulation period.

Looking at the lowest (Min) guaranteed IRRs, AIA’s 0.25% is the lowest of the three. However, the premium payment period for this product is five years, annuity payments begin at age 55 and continue for 10 years, and the total policy term is only 20 years — shorter than Prudential’s 25 years and Manulife’s 40 years.

Some people believe that selecting the highest IRR guarantees a win. The biggest misconception is that these figures actually represent different cash flows for each product, including different payment amounts, accumulation periods and income periods. Do these cash flows suit your needs? For example, among the products above, Manulife’s income period necessarily ends when the policyholder reaches age 85, while AIA’s payments must stop after 10 years.

Generally speaking, when comparing options within the same product, an option with a shorter payment period or annual payments, a longer accumulation period, or a later income commencement date tends to have a higher IRR. However, a high IRR does not mean that the option is suitable for you. Going back to basics, consumers should choose the cash flow that best suits their needs.

Three steps for QDAP policyholders to protect themselves

Many deferred annuity products on the market are highly complex and offer multiple options, such as payment periods, income periods (fixed or increasing) and payment modes (annual, monthly, quarterly, etc.). How can policyholders protect themselves and identify the blind spots of QDAPs?

1. Understand your personal needs: Based on the purpose of taking out the policy, determine a suitable payment period and income period, then ask the insurer or adviser about the QDAP’s IRR. Note: Due to the available options, some products may not offer the income period you want. As a second-best option, check whether there is an income period that is closest to your needs.
2. Make sure you can afford the premiums: Before the end of June this year, financial needs analysis is not required when taking out a QDAP (see Note 2). Policyholders should therefore understand their payment capacity and ensure that they can afford the premiums, avoiding losses caused by early surrender.
3. Compare prices: Products on the market can broadly be divided into those intended for medium-term savings and those intended for long-term retirement planning. The income periods required by these two types of products are completely different. Depending on your objective, you can compare products using 10Life’s Product Decoder to gain an initial understanding. You can then provide your age, gender and smoking status to the insurer or adviser and request personalised guaranteed and total IRRs (see Note 3).

This article focuses only on common blind spots concerning QDAPs, and the examples are for illustrative purposes only. To compare more products, visit 10Life’s Product Decoder. We attempt to compare QDAPs with the cash flows that most closely match the purposes of savings and retirement respectively.

[Compare qualifying deferred annuity policies for savings purposes]

[Compare qualifying deferred annuity policies for retirement purposes]

Notes:
 

1. Qualifying deferred annuity policies must meet specified requirements, including: total premiums of at least HK$180,000; a payment period of at least five years; a minimum annuity payment period of 10 years; the annuitant must be aged 50 or above before receiving annuity payments; the product’s IRR must be disclosed for customers’ assessment and comparison; the guaranteed and non-guaranteed amounts of the annuity must be clearly stated; and the premiums for supplementary benefits (such as critical illness cover and hospital cash benefits) must be clearly separated from the premiums of the qualifying deferred annuity. For details, see the Insurance Authority’s Guideline 19.
2. In response to the development of the COVID-19 pandemic, the Insurance Authority introduced a series of temporary facilitation measures to reduce the risk of infection arising from meetings between intermediaries and customers. These measures were effective until 30 June 2020. They allowed insurers and intermediaries, when selling QDAPs, to dispense with financial needs analysis after clearly disclosing important product information to customers. They also extended the cooling-off period for the relevant policies to no less than 30 days, allowing sufficient time for policy documents to be delivered by post and enabling policyholders to seek professional advice where necessary.
3. According to the Insurance Authority’s guidelines, from 31 March 2020 onwards, insurers are required to disclose personalised guaranteed and total IRRs. 

This English version of this article has been generated by machine translation powered by AI. It is provided solely for reference purposes. In the event of any discrepancy or inconsistency between this translation and the original Chinese version, the Chinese version shall prevail.