Solvency II, the proposed capital adequacy regime for the European insurance industry, claimed a high-profile victim last week when Axa announced it was pulling out of the enhanced annuity market. It gave the reason as “lack of appetite” for a market it had only just entered but also cited the proposed new rules coming out of Brussels, which will require insurers to hold more cash to ensure they can meet their obligations.
Annuities are high on the agenda for advisers. The erstwhile bedrock of retirement planning is being undermined on all sides. Not only have gilt yields been slashed but insurers also have to contend with soaring longevity plus the burgeoning costs of regulatory compliance. Axa surely will not be the last to reconsider its ambitions in the annuity market.
At the same time, record numbers of retirees are facing the prospect of choosing an annuity to provide an income for life as final-salary schemes close, leaving them effectively to provide for themselves.
The situation has been exacerbated in the past few months as pension savers between the ages of 50 and 55 are forced to choose between vesting their pension now while they still can and having to wait until the age of 55 when the rules change in April.
Turbulent markets have also started to reverse the received wisdom that one should hold off taking an annuity for as long as possible – in the expectation that rates will rise with age while the pension pot carries on growing.
Informed Choice managing director Martin Bamford says: “There is no longer any degree of certainty that a client will get a better annuity rate if they hang on.
“Where investors have held on in the equity market, portfolios that have taken a hit in the turmoil of the last couple of years should now have recovered. Annuity rates are better than a year ago and things could get better but this year will be a year of two halves, divided by an election. It looks like there will be a good first half and the upturn could continue but don’t depend on it.”
Alexander Forbes Annuity Bureau director Tim Whiting thinks that now could be a good time to annuitise. He says: “Annuity rates appear to be the only thing that is not frozen solid this January, with many rates on the rise.
“The improvement in annuity rates could offer a window of opportunity for people aged 50-plus to take their pension before the minimum age rises.”
Hargreaves Lansdown head of pensions research Tom McPhail says the state of the economy is adding to uncertainty. He says: “The 10-year gilt yield has gone up to 4 per cent and there are sound arguments that it could go higher. But the big question is what the Government is going to do about repaying its debts and the impact this will have on bond pricing and what type of yield the annuity companies will get. There are lots of unanswered questions and no firm predictions.”
Bamford points out that, even if the gilt yield goes up, it will not necessarily result in a rise in annuity rates.
“The relationship between annuities and the gilt yield tends to be like petrol and the oil price,” he says. “When the price of oil rises, petrol prices rise very fast but if it falls, petrol retailers tend to bring their prices down more slowly. Even if the gilt yield does improve, you could still wait a long time to see an effect on annuities themselves.”
Annuity rates are also the hostage of the rising costs of regulatory compliance and the fragmentation of the market.
Bamford says: “The downward pressures from Solvency II and longevity are likely to be as strong as, or stronger than, upward pressures from an improved gilt yield. We are also seeing the rapid break-up of the annuity pool, the traditional cross-subsidy of the long-lived by those who die early, with the increase in enhanced annuities and postcode pricing.”
‘There is no longer any degree of certainty that a client will get a better annuity rate if they hang on’
Billy Burrows, director at specialist retirement planning firm Burrows & Cummins, says the Axa decision to pull out of enhanced annuities comes as no surprise. “The enhanced market is very competitive,” he says. “Some of the rates coming out for the customer are not profitable for the insurer.
“Postcoding is just the tip of the iceberg. The value you get from annuities is slipping away. If bond yields go up, insurers will not pass on the full increase in their annuity rates. Postcoding is eroding Middle Britain’s retirement provision and those who have deferred in the past now find they have lost value.”
But he reckons that careful planning can mitigate some of the uncertainty. “There is a get out of jail card for people who don’t know what to do about annuities now and that is to take a portfolio approach to annuities and split their savings into some fixed, some with-profits and some flexible annuities,” says Burrows.
If anyone is determined to vest their pension before the rules change in April, they need to get a move on.
McPhail says: “The average turn-round of a pension fund into drawdown is 38 calendar days, so people need to act fast. That is an average delay – some providers take longer. With the cut-off date being effectively April 1 because the Easter holiday runs right up to the end of the tax
ear, that means applying no later than the middle of February.”
But clients should not be bulldozed into annuitising out of fear, as Bamford concludes: “Some people may want to be sure they can take tax-free cash, which always seems to me to be vulnerable to a rule change ever since the Government renamed it pension commencement lump sum in 2006 and took tax-free out of the name. But clients should not be making decisions on the basis of external factors, unless they relate back directly to their personal circumstances.”