View more on these topics

Professional touch Serve and protect Highs and lows of annuities

I have never heard anybody suggest that annuities are exciting. Perhaps I just move in the wrong circles. But whether they are exciting or not, they are fundamental to pension provision in the UK.

It is often suggested that annuities are bad value. People point to how much less somebody gets for each £ of purchase price than people of their age and sex did 10 or 20 years ago.

This must mean that the life offices are ripping off the public and making huge profits, mustn&#39t it? Well actually, no but do not take my word for it.

UBS Global Asset Management has sponsored a pensions research programme at the London School of Economics. You can access the resulting series of papers at www.lse.ac.uk/ubs.

Some of these are, not surprisingly, very academic but you may find some of them very helpful. The eighth paper in the series is called, UK Annuity Rates and Pension Replacement Ratios 1957-2002 by Ian Tonks and Edmund Cannon.

One of the questions this paper sets out to answer is: Are annuity rates unfairly low? They say: “We find no evidence that the average annuity rate in the UK over the period 1957-2002 has been unfairly low.”

They go on to say that the annuity values seem to them to be “suspiciously good” and they turn this on its head by asking the opposite question: Are in fact annuity rates too high? Unfortunately, they do not conclusively answer this question – perhaps they will another time.

Incidentally, the authors found no reason to suggest that people were worse off by annuity rates being low since they concluded that this had been offset by increases in the value of pension funds over the last 45 years.

I think a life office which sells an annuity is taking a very significant long-term risk that the annuitant will outlive any longevity assumption in the premium rate basis. Life offices are required to reserve conservatively for this risk so that ties up capital and the providers of that capital require a reasonable return on it.

Another striking comment on the annuity market is the view taken by reinsurers. I was talking to a leading reinsurer before Christmas and asked him whether any reinsurers were currently taking blocks of immediate or deferred annuity business from primary insurers.

His answer was no, except to the extent that impaired lives might be involved. That suggests to me that the reinsurance market agrees with the authors of the LSE paper and moreover would extend the same sentiment to deferred annuities as well as immediate annuities.

This gives a clue as to why the bulk buyout market for defined-benefit schemes trying to wind up is so thin.

The reinsurance market is a way of injecting capital into the primary insurance market. If the providers of that capital do not believe the product pricing allows for a reasonable return, they can and do walk away.

This may sound removed from the day to day world of pensions but consider the implications. If this analysis is correct, the most likely outcome in the medium term is that immediate and def-erred annuities will become still more expensive, even if there is no change in investment conditions and long-evity estimates.

One possible reaction to this is to dive into annuities today before they get more expensive but I suspect that a more common reaction is that people will look for ways to avoid annuities altogether.

Under the Inland Revenue&#39s pensions tax simplification proposals, it is possible to do that by using unsecured income (or drawdown as we currently call it) then alternatively secured income (ASI) after age 75.

At the moment, ASI looks very restrictive but if future governments accept that annuity purchase is deeply unattractive, it would be easy enough to lighten up on ASI. We live in hope.

Recommended

CML urges Treasury to regulate home reversion

The Council of Mortgage Lenders has urged the Treasury to regulate home reversion plans to put them on an equal footing with equity release. In its response to the Treasury&#39s ongoing consultation into whether it should regulate home reversion, the CML says failure to regulate the market could result in a skewed equity release market […]

NU aggregates £500,000 critical cover cap

Norwich Union is to extend its £500,000 cap on individual critical-illness cover to include other policies either with the company or with rivals. From August last year, a £500,000 cap was put on individual CI applications which will be imposed on an aggregate basis from March, meaning that other policies are to be counted into […]

Equitable clients in court bid over confidentiality

A group of Equitable Life policyholders is taking its case for compensation from the troubled insurer to the High Court after disagreeing as to whether they have an agreement or not on the basis of confidentiality. Lawyer Robert Morfee, a partner at Bristol law firm Clarke Willmott, is representing four parties in the move. He […]

Seasonal boost from Standard

JP Morgan Fleming is offering a discount on its initial charge for investments of £7,000 or more into four funds until April 5. The initial charge will fall from 5.5 per cent to 3.5 per cent on the company&#39s UK dynamic, UK strategic value, premier equity growth and Europe funds. JPMF is also waiving the […]

Newsletter

News and expert analysis straight to your inbox

Sign up

Comments

    Leave a comment