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Govt&#39s recipe for annuities fails to satisfy the appetite

Major pension annuity reform such as the abolition of the requirement to purchase an annuity by age 75 is missing from the Government&#39s long-awaited annuity consultation paper published last week.

Instead, the industry has been asked to consider proposals for limited-period and transferable annuities.

Under the Government&#39s proposals, pensioners could buy a temporary annuity with some of their pension pot. They would be free to choose the period and level of the annuity, so long as they converted the remainder of their fund to an annuity by age 75.

After the term of each temporary annuity expired, pensioners would be able to decide whether to buy a lifetime annuity, another limited-period annuity or go into a drawdown policy until age 75.

The Government believes this would encourage new providers to enter the market as annuities with a limited timeframe would be easier to price.

Such annuities could also help allay some criticism surrounding the lack of death benefits on annuities. If the pensioner died within the term of the temporary annuity, not all their pension pot would die with them.

A further suggestion in the consultation paper is that lifetime annuities could be transferred to other providers.

The proposed products are being hailed for giving some flexibility to pensioners, who would not be locked into their annuity decision for life.

Britannic Retirement Solutions corporate development director Robert Bullivant, who has lobbied for more flexible annuities, says expanding the open-market option will benefit IFAs. He says: “The opening up of Omo will make a big difference to retirement income and this is the natural place for IFAs to be.”

But IFAs are unconvinced that the proposals will bring about real benefits. Intelligent Pensions director Steve Patterson says: “Limited annuities are not going to compare with the mortality cross-subsidy and the returns will not be much better than cash on deposit.”

Annuity Bureau director Peter Quinton says: “The risks on these products could be huge. If the limited period is short, there is less chance for the investment to perform. It will not be as cheap as the Government is hoping. Due to the risk involved it will need ongoing advice, which will put up the cost.”

The Government&#39s agenda also includes decision trees for annuities but many in the industry say a new system of limited-period and transferable annuities would increase the need for advice.

Patterson says: “It seems to want to cut out advice but you have to have an investment strategy just for the funds not used to buy the annuity. So you cannot do this as a low-cost exercise.”

The Government&#39s answer is the Individual Pension Account, which it says could be a holding vehicle for funds that are not used to buy limited-period annuities.

While the Government recognises that giving freedom to transfer annuities in payment would mean less attractive rates, it hopes there might be a middle course that would allow transfers at certain points.

Yet the Government&#39s paper does not really resolve the issue of transferability, which many in the industry struggle to see working in practice.

Scottish Widows pensions strategy manager Ian Naismith says: “I have some difficulty in seeing how transfers would work on conventional or with-profits annuities. There are lots of issues around underwriting and costing. The paper raises the point but does not really seem to have any answers.”

To encourage new product design, the Government says it will alter legislation to allow approval of any new products which meet a set of agreed criteria. Many IFAs want to see more discussion around developing investment-linked annuities which could answer some of the criticisms surrounding performance and mortality cross-subsidy.

Annuity Direct director Stuart Bayliss says: “Wouldn&#39t investment-linked annuities offering multi-company fund links with the ability to swap investment providers inside a single provider be a better idea? That way, you are not locked into a bad performing fund and the longevity insurance is not undermined.”

Scottish Mutual pensions and investment development director Leslie Gray says: “This will be a vast improvement on the current situation where new products have to be forced into a regulatory straitjacket involving lengthy discussions with the Inland Revenue. This can introduce unnecessary complications in the final product design.”

But others think allowing providers to dream up weird and wonderful products for approval will lead to ad hoc policymaking. Naismith says: “There is little information on what it will allow and what it won&#39t. We hoped there was going to be some guidance but it appears to have ducked away from it.

Skandia group marketing Peter Jordan says: “It says it does not want the rules to be too tightly defined but the danger is policy is made on the hoof and every product works in a different way. It is a recipe for confusion.”

But the fundamentals of compulsory purchase at age 75 will not be changed, which will not silence the critics. Some say the consultation paper, running to 66 pages, is a pile of sand in which the Government has buried its head.

Jordan says: “This is a long document which does not really explore anything at all. There is not much in the way of conclusive evidence to justify age 75. The Government has approached this from a very limited perspective.”

The Government is clearly wrestling with its usual paranoia when considering any kind of reform. It wants to encourage people to save for retirement but this is quickly followed by a statement that “pension savings should not become a tax-favoured savings vehicle for non-pension purposes”.

The proposals are firmly rooted in how to increase flexibility of annuities and give pensioners more opportunities to shop around for a better deal every few years.

The Government has set out its stall. It may not impress everyone but at last a set of proposals around which to frame a discussion.

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