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Prudent alternative to compulsory annuities

While the rest of the industry was left despondent following a conspicuous absence of annuity reform in the budget, Prudential was unruffled. This was because it knew something the rest us did not.

Money Marketing understands the Pru&#39s proposition for a radically different annuity was put before Chancellor Gordon Brown, along with a further annuity Project X from a rival life office, ahead of this month&#39s budget.

It seems these developments were enough to see off any faint hopes that the Government would act on the accumulating head of steam surrounding annuity reform.

By looking to the market to deal with the criticisms levied at annuities, but within the current tax regime, Brown has a point. Some experts have argued that any fundamental reform would involve a wide-ranging overhaul of the entire pensions taxation regime. The Treasury itself claims the alternative regimes presented to it would have cost hundreds of millions to implement.

While the likes of the Pru seem content to work within the confines of the current regime, there are increasingly diverse parties seeking to challenge it – not least of these being the Prime Minister&#39s wife, Cherie Booth QC.

Booth is gearing up for a court-room confrontation with the system her husband&#39s Government is sticking by under the European Convention on Human Rights – challenging compulsory annuity purchase at age 75 with the case of Joe Singer. The 74-year-old Preston pensioner and company chairman has drafted in Booth on the grounds that the Human Rights Act, which came into force last year, outlaws prejudice on the grounds of age and that compulsory annuity purchase at 75 years is age discrimination.

Singer says: “If you die shortly after buying an annuity, your children won&#39t get a shilling.” This part of Singer&#39s argument cuts to the quick of what some see as the real annuity “problem”. This goes beyond fallen gilt yields and even the demographic time bomb of relentlessly improving life expectancy.

Skandia pensions marketing manager Peter Jordan says: “While a lot of people are concerned gilt yields are low, this is not the heart of the problem for some who think: &#39If I die, I&#39ve been robbed&#39.”

The Treasury has made it clear it is looking to the industry to solve the problems and criticisms surrounding annuities. It has again, as it did with the 1 per cent charges cap for stakeholder, told the industry to go and figure it out for themselves.

But Conservative Shadow Social Security Secretary David Willetts MP says: “The reform of annuities must go hand in hand with a mission to cut the burdens being imposed on the pensions industry over the past few years. It has had to wrestle with uncertainty over stakeholder pensions, the £163.5 billion raid on pension funds, as well as increasing red tape and complexity.”

So can the Pru really deliver the Chancellor&#39s budget assertion that: “The Government believes developments in the annuity market can help to address some of the concerns expressed”?

Its product is a combination between a traditional annuity and income drawdown. Among other features, it boasts a closed fund where the entire pot is paid to all members through a system of annual “lifetime bonuses” linked to the number of policyholders who die during the course of the year. While technically still an annuity, like drawdown the policyholder will be able to extract lump sums and have a great deal more control over the annuity income.

There are also a number of investment style options, which you can take decisions on up to the age of 90 years, when a default option takes over. But with this flexibility comes a greater investment risk than conventional gilt-led annuities.

In addition, a proportion of the fund is ring-fenced so that if an annuitant dies this can be passed on to the policyholder&#39s family. This can offer higher death benefits, though the family will never get the full value of the fund.

The Pru has acted in its own name and made the prudent move of working under the taxman&#39s gaze (although an Inland Revenue spokesman is keen to stress the Revenue does not work exclusively with individual companies).

This follows a number of high profile products in the 1990s which fell under the taxman&#39s axe. These included Equitable Life&#39s managed fund which was launched in 1994 and banned 6 months after it had been on the market.

The Pru product deals with some key criticisms of annuities, but it can not deal with the issue of the public&#39s perception of early death as a windfall for the life office.

Jordan says: “If all the new products deal with is improving the cross-subsidy between policyholders, then this is no closer to dealing with the core issue than any other product.”

For that part of the annuity issue, reform is still required. It is unlikely the Pru&#39s development will be enough to get the Mr Singers of the country to call off their offensive action against the existing regime.

While the strength of Singer&#39s case is not yet clear, regardless of the useful and Government-stamped developments by boffins in insurance companies, many parties will not surrender until the Government concedes by offering some serious annuity reform.

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