Andrew Tully: The unanswered questions on secondary annuities reform

Andrew Tully White background 700

Next year sees the second phase of the pension freedoms experiment, with existing annuitants being allowed to trade their future income for a lump sum.

While a year may sound a long time, there is a massive amount of work needed to build the framework for a market that works for all parties: existing providers, buyers, advisers and, most importantly, annuitants who want to sell their income.

It is clear why some people may find a sale an attractive proposition. For many, a lump sum in their hand to use as they choose is of greater value than an ongoing income stream they did not really want to buy in the first place.

And there are likely to be some people where a sale is a reasonable outcome. For example, those with very small annuities that are largely irrelevant on an ongoing basis, as well as those approaching retirement who may be able to utilise a guaranteed annuity rate, then immediately trade their annuity to obtain a greater value than was in their pension pot.

However, others are likely to get poor value. It has been suggested those who bought a poor value annuity could use the secondary annuity market to their advantage but we need to be clear: if someone has been locked into a poor income, then the purchase price offered will be based on that.

Trading does not magically get the customer back to a great position. If we want to solve the problem of people buying poor-value annuities the primary annuity market has to work better. A secondary market is not the panacea for the lack of shopping around at retirement.

Intermediaries will create portals to bring potential sellers and buyers together but there are still many unknowns around this market. One of the most troublesome is the potential scale and ongoing longevity of it. It seems clear there will be a surge of people looking to sell their annuity when the new rules are introduced in April 2017 but once that initial rush is over, there will be a much lower number trying to trade their annuity on an ongoing basis.

And as not all those who consider selling their annuity will proceed once they receive an offer, it will be difficult for companies to determine if it is worth investing in technology and infrastructure for what could be a small market with a relatively limited lifespan.

There are other practical issues to overcome, too. This will be permissive legislation, so it will be up to existing annuity providers whether they allow their annuitants to trade or not, and not all annuitants who want to sell their annuity will be able to do so. In addition, buyers will want to see the detailed fine print of the annuity terms along with health details of the customer and any dependant. This will take time to gather and some potential sellers may be put off by the slow process.

Buyers need to have suitable risk appetite and substantial capital resources, as well as knowledge and experience of mortality, and the impact health and lifestyle can have on life expectancy.

For some buyers there is also a huge elephant in the room in how this asset will be treated for Solvency II purposes. This all means there may be a relatively small group of buyers and some may only want to buy back the annuities they originally sold.

Some advisers may not want to get involved in this market. However, a lot of current or previous customers with annuities will come to you as the first port of call, so you need to have a position on whether you help these people or where you direct them to.

There is a potential market for advice as it is a requirement for annuities valued over a certain (as yet unknown) level, although it does seem likely many of the sales will be among lower-value annuities.

The FCA paper due in the next few weeks may answer some of these unknowns. But there remains a huge amount of work to be done if there is to be a functioning secondary annuity market in place by April next year.

Andrew Tully is pensions technical director Retirement Advantage