Providers are continuing to back annuities despite a mass exodus from the market amid predictions that a “perfect storm” could lead to the sector becoming unviable.
LV= is the latest provider to rethink its enhanced annuity offering, having entered discussions with staff about plans to quit the market last week. This Wednesday, it decided on leaving. Standard Life also pulled out of the open annuity market earlier this month.
The FCA is also investigating several providers over historic non-advised annuity sales which is thought to have contributed to some firms feeling exposed.
Who is left?
According to Hargreaves Lansdown, six providers have withdrawn from offering the open market option since pension freedoms were announced. Reliance Mutual was the first to leave in July 2014, Friends Life exited after its merger with Aviva in April 2015 and Partnership also left the market after its merger with Just Retirement in April 2016. Prudential, Aegon and Standard Life all withdrew this year but still offer in-house annuities.
Aegon UK chief executive Adrian Grace says it is difficult for providers to be good at everything and understands why more firms might be considering pulling out of annuities.
Grace says: “We are very clearly moving out of traditional risk-based products that life and pensions business have historically made most of their strategic plays on. We are moving out of annuities, but we won’t be the last to do that. Others will see that annuities don’t have a bright future and look for alternative vehicles to make money.”
“The annuity market has shrunk because of pension freedoms,
it has probably reached the lowest level it will get”
Hargreaves says it still offers a “whole of market” annuity service through eight firms. Aviva, Canada Life, Legal & General and Retirement Advantage have a standard and enhanced offering, while Just Retirement, Scottish Widows and LV= are solely enhanced, and Hodge Lifetime is solely standard annuities.
Hargreaves Lansdown retirement policy head Tom McPhail says the environment post-pension freedoms is a “perfect storm” for annuity providers and warns of the future viability of the annuity market.
He says: “Pension freedoms have boosted demand for drawdown as an alternative to annuities, monetary policy has driven down interest rates to unprecedented levels, which has squeezed margins, and tough solvency requirements have imposed high operating costs on the insurers. It is hardly surprising so many companies are choosing to review their terms.
“The risk to investors is if this trend continues, one day soon the UK may not actually have a viable annuity market at all. That would be bad news for millions of pension investors who will want to buy a guaranteed income in years to come.”
The regulation factor
Regulatory changes have been cited as a key factor in providers reassessing their annuity offerings. The European capital regime Solvency II, which came into force in January, requires insurers that sell annuities to hold enough capital to pay customers if they live longer than expected, or if funds backing them perform worse than expected.
Aberdeen Asset Management retirement savings head Gregg McClymont explains the solvency requirements have had a particularly large impact on insurers that are unable to move towards higher risk assets to back their annuity products for regulatory reasons.
McClymont, a former Labour pensions spokesman, says: “You have to hold a lot of capital on your balance sheet to be an annuity provider. The requirements in a low rate world are tough. It’s tough as a big insurer to get the returns you need to back your policies when yields are so low.
“No one’s got a crystal ball, but there’s no particular reason why ‘lower for longer’ is going to disappear suddenly. Because firms are providing guaranteed products it’s a particular challenge; you can’t just move up the yield curve, you have to be doing things that have very little risk attached that meet the requirements of regulators for assets to back their policies.”
LV= has cited changes in retirees’ buying habits since pension freedoms as one of the factors behind its proposal to stop offering enhanced annuities.
Retirement Advantage pensions technical director Andrew Tully agrees the market has contracted since the reforms but says there is still a demand for guaranteed income products.
He says: “There are people who still want some certainty or level of guarantee whether that is for the whole pot or part of the pot. There is still a demand for annuities although that demand is lower than it was a few years ago. Pension freedom has seen the annuity market shrink, it has probably reached the lowest level it will get.
“There is still a competitive annuity market out there. In the last four or five weeks we have probably seen annuity rates go up 5 or 6 per cent. Part of that is down to gilt yields but part is also down to competition. Even at a time where we have seen some providers dropping out we have seen the market going up.”
“Others will see that annuities
do not have a bright future
and look for alternative vehicles to make money”
However, research by Moneyfacts suggests 2016 is “the worst year ever for annuity rates”.
The research suggest the annual standard annuity income fell by 6.4 per cent and the average annual enhanced annuity income dropped by 10 per cent between July and September.
Data from the Association of British Insurers suggests in the three months to April, the latest data available, the amount invested in annuities fell from £1.1bn to £950m.
A contracting market can signal concerns for consumers who have less choice in annuity products. Tully also says it is important for annuity buyers to shop around to sure they are getting the best deal.
He says: “One of the biggest issues is to get people shopping around for those competitive rates on the open market. About 60 per cent are still just buying from the holding provider. That is a bigger consumer detriment that people are just rolling over and buying an annuity from the company they are saving up with.”
Fairer Finance managing director James Daley has an optimistic outlook on providers leaving the market and considers there is still a demand for enhanced annuity products.
He says: “This has been triggered mostly by the pension freedoms and more people taking an active part in deciding what they are going to do in retirement. Hopefully that means that more people are getting a better deal overall.”
Historically, annuities have always had a really important place in people’s retirement planning but since George Osborne’s freedom and choice speech people’s buying behaviour is beginning to change. People are starting to look at shorter time horizons rather than the permanent decision of an annuity. We have seen a rise in fixed-term annuities and guaranteed drawdown and, at the same time, we have been in a low interest environment for a long time. We have got more stringent regulation coming through in Solvency II and it is a tough environment to deliver an annuity that gives a positive outcome for the consumer.
Solvency II puts constraints around the kinds of assets that can be used to back annuities, which means there is a smaller group of assets that can be used. To some extent, those assets are also the assets that are being purchased up by quantitative easing so it is quite challenging to find assets producing enough yield to create income for annuities.
That said, we still think annuities have a place and fixed-term annuities are becoming more and more popular and are a viable option. A fixed-term annuity can generate value to be returned to savers at a particular point in time. Importantly, people are looking at how their retirement might play out, how much income do I need right now in what might be an active phase of retirement versus what income will I need in the future. There are a variety of ways people use fixed income annuities alongside drawdown to plan their retirement in phases.
At the end of this consultation if we do stop offering enhanced annuities we will be plugging that gap by other products available in the market. Just because we do not manufacture them does not mean we do not think they are good so we will use other people’s products.
Philip Brown is policy head at LV=