I use a slide for presentations which contains a few statements relating to the debate over whether or not annuities should be compulsory. They include: “Annuities are legalised theft”, “Annuities are one of the biggest rip-offs of all time” and – my all-time favourite – “Almost anything has to be better than the present system. I think that my dog could have done better.”
These statements were responses to an online survey by Interactive Investor in 1999 but they are still relevant today.
Why do people hate annuities? There are three main reasons. Annuities offer no lumpsum payment on death, they are perceived as offering poor value and have no flexibility.
There have been many attempts to answer these criticisms. Income drawdown was introduced to avoid the problem of buying annuities at low levels. However, in many cases this has made the problem worse because people deferring annuity purchase have ended up buying annuities at even lower rates.
More recently, the Government and the Inland Revenue have tried to answer the criticism that annuities do not provide a lump-sum benefit by introducing the so-called money-back option in the plans for simplification. The trouble is that by restricting this option to age 75 and imposing a 35 per cent tax on the final payment, the option becomes decidedly unattractive.
The lack of flexibility in annuities is being tackled in two ways. Pension simplification introduces the concept of an alternatively secured pension – in other words, income drawdown beyond age 75 but with no lump-sum death benefit. Unfortunately, drawdown beyond age 75 without the ability to pass the fund on to the next generation will not be popular. It remains to be seen whether the fund can be transferred to other members of the pension scheme.
The Government also hopes that insurance companies will design more flexible annuities but the industry does not have a good track record in annuity innovation.
What does all this mean for the future of annuities? Paradoxically, if we take all the criticisms and false assumptions of annuities and turn them on their head, we can see that some of the perceived disadvantages are actually strengths. Annuities are still the only financial product which can guarantee a high level of income for the rest of an investor's life – how ever long that may be – and with the peace of mind and security sought by investors of a certain age.
There may be no lump-sum death benefits, yet investors are offered insurance against longevity. Lack of flexibility translates into securing a high income. In short, annuities meet many of the objectives of those pensioners who want to maximise their income.
Turning to the trend for annuity rates, this year began with most of the major insurance companies cutting their rates in response to falling gilt yields. Some companies used their annual review of mortality assumptions to adjust for increased longevity by lowering some rates.
There was little activity in February and early March, with the exception of Friends Provident, which increased single-life rates, putting it at the top of the tables for single-life annuities, before it reduced its rates on March 10.
During April, Prudential, Norwich Union, Legal & General and Canada Life increased their annuity rates but Clerical Medical and Scottish Widows cut rates. Prudential was the first company to increase its rates, putting it at the top of the table for most options, closely followed by L&G, NU and Canada Life.
The current trend reflects rising bond yields as well as the competitive nature of the market as companies look to consolidate market share. More rate increases may be in the pipeline as bond yields are moving towards 5 per cent. If yields pass this psychologically important level, it should trigger companies to further increase annuity rates.