This year’s Budget statement confirmed that up to five million pensioners are to be given new flexibility to trade in their annuities for cash from next year. The rationale is to ensure that people who have already purchased an annuity have access to the same pension freedoms now in place for those approaching retirement.
The proposed scheme is currently under consultation, with the basic principle being existing pensioners will have a new option to sell their annuity income to the highest bidder. But how could this potentially work and who will really be able to benefit?
Well, firstly, the people most likely to benefit from this greater freedom will be those with low annuity incomes who were forced into buying one to crystallise their small pot. An amount of £10,000 will be more appealing than £20 a week income, especially if in poor health. Also those with other secure incomes, via a defined benefit scheme for example, that exceed their requirements in good health could benefit.
In terms of the potential size of the market, there are around five million annuity holders in the UK. If the average case size is circa £35,000, then this is a potential £150bn market. Not all will wish to cash in their policies and for some it will offer poor value. However, if around 30 per cent decide to encash then the market in traded annuities may be worth £50bn.
How the market may operate
Although the consultation is ongoing, if we use traded life policies as an example we may see the market develop in three main ways:
- Product providers buying policies from existing clients
- Traded annuity policy companies being set up to purchase policies from clients
- Traded annuity policy companies re-selling purchased “lives” to those clients seeking a better annuity price in the second hand market
The main difference in the new market will be that the client’s state of health and anticipated longevity will be pivotal in deciding what premium can be or will be paid for a stated policy.
Any trading circumstances where the client has little knowledge or understanding of the true value of the policy they are selling means clients are at risk. They may have already been placed into a poor value policy by buying direct from the provider without an enhanced or impaired option and without using the open market option.
Any advice given in this area will require a clear and detailed assessment of an annuitant’s health and anticipated longevity. There will be a demand in the market for tools and health assessment processes that can deliver this report. This will then be used to price an annuity. Healthier annuitants will potentially receive better surrender values than those in poorer health.
The second hand annuity market, where a company will then re-sell the annuity to another individual life, will then operate as it does now. However, it should be noted there is currently no process to re-assign an annuity to another life.
The process for trading annuities has not been made clear. It is unknown how much detail has already been thought through within the Treasury and FCA. Early indications suggest the tax charge for cashing in the annuity will be at the client’s highest marginal rate.
Implications and opportunities for advisers
The press surrounding this will undoubtedly mean there will be client driven demand for this transaction to take place but a market does not currently exist and supply will be limited.
In terms of opportunities, however, once we have FCA guidelines and supply improves this could be big for advisers. Many will have considerable back books of existing annuitants and also many clients approaching providers direct will be referred to advisers through Pension Wise and Unbiased, as they are currently required to do so under the “second line of defence” requirements.
However, The implications of advising a client to give up guaranteed income for life, in many cases, will still carry the same level of risk as defined benefit to defined contribution transfers.
In summary, there could potentially be a large market for traded annuities post-April 2016 but one where, more than ever, consumers will need to seek advice.
Richard Bartlett is head of auto-enrolment and at retirement at Intrinsic Financial Services