EUROPE - Academic research suggests European pensions policy could give pensioners increased potential retirement income and flexibility in the long-term by allowing pension pots to be diversified beyond mandatory annuities across the life of the payout phase.

A study was unveiled in Brussels yesterday by Professors Raimond Maurer and Barbara Somova of Goethe University in Frankfurt, and commissioned by the European Fund Administration and Management Association (EFAMA), concluding a retiree "can expect to consume more over the complete lifecycle as compared to full annuitisation" if survival probabilities are taken into consideration and assets are invested more flexibly through a collection of annuities, equities, bonds and money market holdings.

A 115-page report detailing the academic comparison of factors affecting the payout phase of pension suggested a German female with no bequest motive would be able to "consume more until the age of 82 compared to a full annuitisation strategy" if she were not required to invest in an annuity from the age of 85 as greater potential investment returns could be generated through diversification.

The report itself looks at several aspects of economic and regulatory aspects of the pensions payout phase, and how this influences decisions and capabilities of both investors and regulators.

More importantly, however, the analysis conducted by Maurer and Somova - by applying a Monte Carlo simulation of 10,000 life cycles - suggests if a pot of money and strategy is rebalanced at retirement to work out how it might be consumed - the sum would stretch much further if assets are diversified beyond annuities.

Maurer noted in his presentation of the report yesterday that there is a tendency in Europe to apply the mandatory purchase of annuities at retirement. However, if the person dies within the first year of buying the policy the investment return is -100% because all money is lost to the annuity provider, and to the benefit of other investors.

He also acknowledged it is not possible to definitely say buying an annuity is a lesser option - as there are obviously disadvantages to not eliminating all longevity risk - but had found individuals were unhappy about the inability to bequest assets and hand over the full pot with no further control.

"What people do not like is you have to give up control of your retirement assets, you are a creditor of your insurance company. Is this survival credit sufficiently high enough to compensate this disadvantage? If you have to bequest money, you can never invest all of your investment in annuities.

"There should be some kind of integrated retirement product where you can introduce all elements: stocks, bonds, money markets, life annuities. It should be used with an IT realisation. But this is not a cheap product.

"My favourite restructuring would be to look at the poverty level and below that buy an annuity to top it up. If above [the poverty level], you should allow people to invest in other products. But products would need more risk control mechanisms," he added.

The analysis suggests were a woman aged 65 with a 10% risk aversion to gradually shift the retirement policy from stocks into bonds and eventually annuities by the age of 87, she could eventually draw down her income to a steady €26,000 per annum at the age of 87 compared with €15,270 were she to buy an annuity at 65.

Among the key issues discouraging many policymakers from allowing lifetime drawdown is both the tax gains they generate for treasury departments, noted the report, as well as the paternalistic nature of governments who do not want to be left bailing out individuals who run out of money before the end of their lives.

It is a concern also acknowledged by Pablo Antolin, principle economist at the OECD"s financial affair division and directorate for financial enterprise affairs, though he said the OECD "completely endorses" everything set out in the report and the potential for more innovative pension payout options.

"If there is clear flexibility in the accumulation phase, it makes sense to have full flexibility in the payout phase," said Antolin.

"The argument is [governments are] paternalistic because of the fear of [money] being squandered. Countries providing a significant level of retirement through pay-as-you-go and defined benefit pensions would be better off to allow more choice and flexibility.

He continued: "But in some central and Eastern European counties DC pensions are the main source of retirement income, so they need to enforce some kind of annuitisation on a larger share of the assets."

Antolin suggested in his response to the report that increased payout flexibility would of course come at a higher cost to those who choose it, but also recognised investing in other assets adds risk to the returns potential, especially as in recent months pension pots have dropped in value just as people are required to buy annuities with them.

"We should be able to address the risks associated with the time of retirement but we don't have a definite one. The more the saving period increases, the probability of a worst case scenario falls (5% at 30 years) however the magnitude of the potential loss increases. Even in combined pooled and non-pooled solutions, there is still a 10% possibility of worst case scenarios."

But he added: "Everything in the report we completely endorse, we would just change what we consider is more important. The country context is the key thing. Countries where assets are included in the DC pension plan are the main source of retirement, so they should mandate that part of their assets buy a deferred life annuity. The rest of the assets should have full flexibility and choice. Financial institutions should also be encouraged to develop products that address issues such as healthcare."

Antolin will present an OECD paper on the impact of the recent financial crisis on pensions to the G20 summit in April.

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