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Billy Burrows: The future role of annuities

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”The annuity apocalypse is overhyped” was the headline in an article recently. This contrasts with another headline, “Annuity sector faces 75 per cent fall after Budget reform to pensions”, which appeared two weeks before in the FT.

So what is the new reality; melt-down in the annuity market or a stable and healthy market?

The answer depends on future customer behaviour and this will be influenced by whatever guidance or advice people are given and what messages are sent out by the Government, the media and advisers.

One of the challenges is to overcome the negative publicity that annuities have attracted. This is nothing new; who remembers the eloquent words of Lord Grantley speaking in a House of Lords debate on pensions in October 1997 when he said: “In my view, there are two overwhelming reasons why people should not invest in annuities under any circumstances. The first is that investing in annuities is contrary to the interests of a family … in that they are worth nothing when the investor dies. The second reason is simply that annuities are a lousy form of investment.”

Of course these two criticisms can easily be defended. Annuities will continue to be popular because they are the only policy that can provide an income for life no matter how long the annuitant lives. For most families the risk is not that the mum or dad die too early but they live too long. In any case most married people invest in a joint life annuity so Lord Grantley was simply wrong in his criticism about this.

However I have sympathy for his other criticism because the rate of return from a guaranteed annuity is low. An annuity is like a mortgage in reverse in that the annuitant is repaid the original capital plus interest. The only problem is that the underlying interest is about 2 per cent. Enhanced annuities may pay a higher income but the underlying interest is the same it is just that the capital is paid back over a shorter time.

There is a simple answer to the low interest rate problem and that is investment-linked annuities. Future payments are linked to equity prices so there is potential for future income growth. Of course the income could fall so these are only suitable for those who can risk.

In the future there will be a very strong case for annuitisation as this is the only way of insuring that the individual does not run out of income. Therefore we should expect a number of new types of annuity products, especially those that solve the low interest problem and provide more flexibility. However we should not underestimate the appeal of a guaranteed income for those who are risk adverse.

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Billy Burrows is director at Annuity Line 

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