It is no longer a question of “if” we will get a secondary annuity market, or even “when”. At the end of 2015, the Government confirmed plans to extend the pension freedom rules to those who have already retired would be delayed for a year.
This means from April 2017 existing annuity holders should be able to cash them in on a second-hand market. But while the Government set out a broad framework, many of the details as to how this market will operate are still to be resolved.
According to Pricewaterhouse-Coopers UK insurance leader Jonathan Howe such details will determine the success, or otherwise, of the initiative.
He says: “The insurance industry has been broadly supportive of the proposals, but whether individual companies wish to take part depends to a large extent on the practicalities of the regime. A number of important factors still need to be considered.”
Provision of advice
Some of the biggest questions revolve around consumer protection; in particular, at what point annuitants will be required to seek advice.
Aviva head of financial research John Lawson highlights the fact that, under the pension freedoms rule, those cashing in pots of more than £30,000 need to demonstrate they have received advice.
“The Government has made it clear similar principles will apply when selling an annuity. We just do not know at what level it will kick in,” he says.
The obvious solution is to align the two but this raises the question as to how annuities are valued. Lawson urges those in charge not to make the rules more complex than they need to be.
“Rather than complicated calculations to convert an annuity back into a notional pension fund, let’s say if your annuity pays more than a fixed amount – £2,000 a year, for example – you need to get advice,” he says.
He warns too many administrative hurdles will push up costs and could end up scuppering this market from the outset.
Standard Life head of pensions strategy Jamie Jenkins says more work needs to be done on managing customer expectations and ensuring an effective advice regime is in place. “People may have had a £50,000 pension pot and bought an annuity that has, to date, paid them £10,000 in income. But this doesn’t mean its residual value is £40,000,” he says.
“Most consumers think of an annuity as an investment product but it is an insurance policy. If their health has deteriorated, or if they weren’t in good health to start with, they are looking at a significantly smaller ‘cash-in’ value.”
Jenkins points out they may have bought it as part of a pooled risk but it will be individually underwritten if they want to sell. Some will get a worse price as a result. If there is not a competitive and efficient market with a range of buyers this could dent cash-in values even further.
What is more, the price of much-needed advice on selling an annuity may mean the sale is no longer cost-effective, particularly for those with smaller policies. The Government has indicated Pension Wise could be involved in this market.
Retirement Intelligence director Billy Burrows says consumers need to understand the cash value they are offered is likely to be significantly less than the long-term value of the annuity.
While this does not mean it will not be an attractive option for some, he says, it is likely to appeal most to those at the top and bottom of the income scale, and may not be appropriate for the typical “middle income” pensioner.
Howe says: “This raises the risk of consumers making bad decisions and with the potential for the blame to fall with the insurance industry participation [in this market] may be limited.”
Indeed, insurers need urgent clarification on how they value purchased annuities against solvency ratios. They are currently awaiting guidance on this from the Prudential Regulation Authority.
Lawson says: “These are likely to be attractive assets and help insurers and pension schemes manage existing liabilities. However, until we get further guidance on how they will be valued, insurers will be reluctant to develop the systems needed to deliver an efficient market.”
He believes this is the first issue regulators need to resolve. If there is not demand from institutions, there is not a market to sell into.
Third party market makers
Meanwhile, the Government has reversed its decision to stop insurers buying back their own annuities. For higher value annuities, however, they will only be able to purchase them through third parties via an “indirect” market.
The Government is yet to confirm how this will work. It is likely to be the same limit that requires customers to get advice, but this has not been ratified. Howe says: “If a range of quotations are to be provided, then the insurance industry will need to consider some form of platform where the annuity holder can share their details to allow a number of companies to quote.”
MorganAsh founder and managing director Andrew Gething says administrative costs could be reduced if third parties can medically underwrite applicants, share this information with potential buyers, then collate quotes centrally.
He says: “We’d like to see a ‘blind-bidding’ process to ensure existing insurers provide competitive quotes. We could establish in advance what the cost savings would be if the insurer buys back their own annuity and factor this into results. This should ensure insurers provide competitive quotes but that the consumer gets the benefit of any cost savings.”
This should boost competition and help to create a more efficient market, he says.
Death and spouses
Attention also needs to focus on what happens when the original annuitant dies. People who sell on an annuity have no further contact with the original insurer, which raises the question of whether there should be a central body to ensure prompt notification of registered deaths.
Similarly, insurers entering a secondary market need to be confident that a spouse, ex-partner or other beneficiary is not going to make a claim on the policy. Jenkins says: “Neither of these problems are insurmountable.
But we need to think about how we can provide adequate protection for buyers without increasing cost and complexity for consumers.”
With the April 2017 deadline looming it is critical these issues are resolved as soon as possible. Jenkins says the decision to push it back a year is welcomed but it is imperative the planned consultations take place as soon as possible.
He says: “If it slips to the second half of the year this doesn’t leave long for insurers and third party market makers to develop the required systems.”
He warns a “slow start” or soft-launch may not be an option. “There is clearly a pent-up demand from consumers which is likely to wane over time, not increase. We need to have systems that are ready to cope with this demand from the outset.”