When then-chancellor George Osborne announced the pension freedoms in his 2014 Budget, it looked like the beginning of the end for annuities.
“No one ever needs to buy an annuity again,” he said in no uncertain terms.
The market was left reeling: share prices of annuity providers plummeted and commentators were preparing their obituaries.
But while annuities have clearly been on the ropes, Osborne’s blow was not quite enough to knock out the market if analysis by RBC Capital Markets is correct.
RBC believes the annuity market has bottomed out after falling 90 per cent by volume and 70 per cent in value since the pension freedoms announcement. It is forecasting 5 per cent annual increases in individual annuity sales as a greater number of people retire with defined contribution pots and look to the products, with open market insurers set to benefit from this growth.
But is this an accurate picture of what we can expect? In what circumstances will people continue to annuitise? And will the annuity market of the future look vastly different to that before pension freedoms?
The problem with annuities…
Annuities provide a secure level of income for life but the flip side is they lack flexibility. People are potentially locked in to low rates for life if market conditions are not great at the time of purchase.
Metlife UK wealth management director Simon Massey says: “What we’ve seen from the data since pensions freedoms and, to a certain extent, the phrase Osborne used about nobody needing to buy an annuity again is a nod towards the fact annuity rates have fallen in line with interest rates and the perception that they offer poor value for money.
“There has been a significant shift away from annuities towards drawdown plans. Advisers are still advising on annuities but it is not a big part of what they are doing. I can’t see the market recovering while interest rates are so low.”
“Part of the reason for a drop in annuity sales is likely to be due to a delay in purchase, rather than a decision to never buy one.”
A return to growth?
Just’s observations on the individual annuities market chimes with the views of the RBC analysts.
Just group communications director Stephen Lowe says: “We recognise a lot of what RBC is seeing in our business. We think we are starting to see the market return to growth but it is too early to call.
“Growth is coming from greater take-up of open market sales — standard annuity sales are dropping off the edge of a cliff. Everything is individually underwritten.”
Lowe explains some of the big life insurance companies are not manufacturing annuities themselves but will use other providers in the open market.
He says: “They are not saying their customers don’t have these needs. It might be because their business models can’t generate guarantees the way that other businesses can. They might be taking a best-of-breed approach through the open market and from a consumer perspective that is a positive thing.”
Royal London pensions specialist Fiona Tait thinks annuity sales are likely to increase, but not to the levels seen prior to pension freedoms.
She says: “Annuities are still the only option for those who want to secure a known amount of income for the remainder of their lives.
“The increased flexibility of other options such as drawdown is looking to be very attractive. However, many consumers who take advantage of this flexibility in the early years of retirement are still likely to experience considerable changes in their circumstances in later years, so may well find themselves turning to annuities when they get older.
“With this in mind, part of the reason for a drop in annuity sales is likely to be due to a delay in purchase, rather than a decision to never buy an annuity.”
Intelligent Pensions head of pathways Andrew Pennie agrees people will annuitise later in life. He believes the recovery predicted by RBC will play out in two ways.
“There are two parts to it. People can use an annuity to provide a secure income in retirement, especially people who are in drawdown now but don’t want to take on risk. They shouldn’t be there; they should be in annuities.
“Drawdown also becomes less suitable as you get older, so many people in their 70s should be in annuities where drawdown can’t keep up and there’s a risk of running out of money.
“For a lot of people, it’s not whether they annuitise, but when. That is unless they have a lot of money and they can take on the longevity risk. At some point it is better to annuitise if you are trying to manage risk, but buying an annuity later in life.”
The wrong end of the see-saw
Deciding whether and when to annuitise depends on numerous variables and individual circumstances that apply at that certain point in time. So how are advisers dealing with the huge responsibility of getting it right?
Lowe sees advisers as “architects” of clients’ financial plans, working to meet a hierarchy of needs.
He says: “In financial planning terms, it means having sufficient guaranteed income for things like food and ongoing bills. Sources for that guaranteed income may be a state pension, defined benefit scheme or an annuity.”
Once advisers have addressed the client’s basic financial needs, they should look at doing fancier things with other assets, such as having a range of funds in drawdown. However, as Lowe points out, the exact course of action depends on individual attitudes and financial resources, which will change over time during different stages of life.
He says: “Some clients want everything secured while others want to take a risk with all of it. When segmenting this market, it is not all about wealth. Some people have an innate need for security.”
At a recent event hosted by Royal London, actuary firm Milliman senior consultant Russell Ward shared the findings of its white paper analysis of retirement guarantees. The firm looked at different product types, from index-linked annuities with the highest level of guarantee, to drawdown with no guarantees, under a set of 1,000 different economic and market conditions.
It found even modest guarantees could return around 30 per cent less over the average retiree’s lifetime than a similar product with no guarantee. But guarantees did provide protection under adverse market conditions.
Ward says: “Value for money comes down the further down the spectrum you go. Insurers who provide the guarantees need to manage the risk, so they have conservative investment strategies that produce lower returns. Set against that is the protection provided by the guarantee in adverse investment conditions.
Our analysis found there is no single option that meets the income needs of everyone in all conditions. But it is important to retain flexibility as circumstance change. Guarantees are a trade-off between security and flexibility with higher returns.”
But it appears there is plenty of work to be done before that trade-off registers with consumers.
Pennie says: “I don’t think people have got it yet that with flexibility comes risk and with security you have no flexibility but you do get a guaranteed income. A lot of people are getting on the wrong end of the see-saw without realising it.”
Tisa policy director Adrian Boulding believes we will eventually see some innovation in the market, with products designed for the new environment. He says: “Although we recognise the importance of a guaranteed lifelong income, we do not expect to see any meaningful recovery in the annuity market until consumer concerns are addressed.
“The traditional annuity is an inflexible product that does not sit well with the new pension freedoms. We expect to see customer-friendly products emerging that will combine the longevity protection offered by an annuity within new structures more suited to the pension freedoms.”
Adviser view: Billy Burrows, director Retirement IQ and adviser at Better Retirement
There is nothing wrong with the annuity concept but various factors such as low interest rates and the continued increase in longevity have kept rates low. But I think interest rates are set to rise and the million dollar question is: at what point will annuities start to give drawdown a run for its money?
At the moment, annuities are relatively poor value. Gilt yields are around 1.8 per cent and need to rise to over 2.5 per cent before they can start to challenge drawdown again.
I do not think annuities will be sold in the same volumes as before but they will become an increasingly hard act to beat. We will probably see less very small amounts being used to buy annuities, as it may be the better option to take the money in cash. But there will still be a group of people with pensions that are too big to take just in cash but not big enough to do drawdown properly. They will go down the annuity route.