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Rising from the ashes: Will annuities recover from Osborne’s Budget bombshell?

Partnership, the insurer whose share price was savaged in the wake of Chancellor George Osborne’s Budget bombshell, is predicting a dramatic turnaround in annuity sales over the next two years. 

Despite the seismic impact of the pension freedoms announcement, the rapid growth of pension savings will push the annuities market to new highs, experts predict.

Savers’ fundamental desire for certainty will also ensure a “swing back” to annuities, though they will have to be repackaged to overcome a tarnished reputation.

But can the market devastation wrought by the Budget really be reversed so quickly? Or is the 2014 sales lull the new normal?

The Budget

Nearly a year ago, the Chancellor stunned the industry as he declared that “no-one has to buy an annuity”. While this technically has been the case for years, Osborne’s words sent the stock prices of annuity providers tumbling as market analysts predicted colossal falls in annuity sales.

Specialist annuity providers Partnership and Just Retirement fared particularly badly, with both firms’ share price roughly halving in the immediate aftermath and barely rising since.

But Partnership chief executive Steve Groves claims the firms’ annuity sales could be back to pre-Budget levels within two years and that the stockmarket’s valuation misunderstands the future of the retirement market.

“The market doesn’t know how to value the Budget,” he says. “On the day of the Budget our share price fell to roughly the value of the business we’ve written and it’s stayed around that level. That’s the market saying we don’t know how to value this company at the moment.” 

Groves says despite the overnight decline of annuit sales, the sheer speed in growth of the pensions market will quickly offset the falls.

He says: “You should view the Budget as a one-off shock. Let’s say half as many people annuitise as used to. But there’s still a wall of money coming through and it still grows at 15 to 20 per cent a year.

“When the mist starts to clear for people, they will come back to the view that this is a growing business and will move away from an embedded value basis and towards a franchise model valuation, but that probably won’t happen until after the Budget changes come in.

“Let’s say it fell 50 per cent, but the value of defined contribution pension pots coming to retirement is growing at about 15 to 20 per cent for the next 30 years. In two or three years you’d be back to the level we were in 2013 even if nothing else happened. The retirement market has some very big structural growth drivers, the biggest being the fact the volume of money being saved is going up and up.

“I don’t think we’ve seen the high point of the UK annuity market.”

Back from the dead?

In the days following the Budget announcement, equity analysts at Barclays Capital projected annuity sales would fall 60 per cent.

Barclays European insurance research director Alan Devlin agrees with Groves that the peak of the UK annuities market may not yet have been reached.

But he sticks by his original prediction that sales would fall by two-thirds within two years and warns annuity providers seeking to move into new product areas may struggle to be competitive.

He says: “There are three growth indicators to look at. Firstly, the amount of people retiring each year – the amount of money being invested is growing given the demographics and the continued move from defined benefit to DC pensions.

“Secondly, if you look at the US, people don’t buy annuities at 65, the average age of someone buying an annuity is 73, so we are probably in a hiatus at the moment. People who haven’t bought an annuity since the Budget may buy one in five or seven years’ time.

“Thirdly, at some point if interest rates go up the relative attractiveness of an annuity increases. No-one knows if or when that will happen but the annuity market’s share of the retirement market will grow if it does.”

Barnett Waddingham senior consultant Malcolm McLean adds: “I suspect the markets probably are undervaluing annuity providers.”

But not all annuity providers are as optimistic. LV= Retirement Solutions managing director John Perks thinks Groves and Devlin have underestimated the eventual fall in sales. He says the market could end up dropping 75 per cent as new types of blended products take market share.

Aviva head of pensions policy John Lawson is also not confident annuities will make such a sudden comeback. He says demographics will slow the number of people hitting 65 as the baby boomer generation is replaced by the lower birth rates of people born in the 1960s and 70s.

He argues small pots will simply be taken as cash and that it will take “10 to 15 years” before average savings are large enough to make annuities attractive again.

But Morningstar Investment Management co-head of investment consultancy and portfolio management for EMEA Dan Kemp says the Budget reforms themselves will add to the more natural growth of pension savings engineered by auto-enrolment.

“One of the impacts being missed from the Budget is the change on younger savers,” he says. ­”If you know there’s that flexibility in retirement you’re more likely to use a pension. That in turn will lead to growth in the at retirement market, including the annuity market.”

Kemp thinks the annuity market’s growth will come through propositions with “different shapes” to the standard lifetime product.

Rebrand

Experts say providers will have to work harder to sell the concept of an annuity, something that was seen as unnecessary when the vast majority of people effectively defaulted into contracts.

Advisers and insurers will also need to ensure savers look past the negativity associated with annuities and focus on the benefits of guaranteed income.

“I am afraid the expression ‘annuity’ has become a dirty word in the minds and imagination of many consumers”, says McLean.

“That together with the lure of cash will inevitably mean that many people will do the wrong thing from this April and deprive themselves of that regular guaranteed income for life that only an annuity ­can give and which, in their heart of hearts, I am sure they would prefer.”

MGM pension technical director Andrew Tully says: “Annuities almost didn’t need to be sold in the past. Now it’s up to annuity providers to show they are value for money.

“Undoubtedly people want the key features. Money turning up in the bank account every month like a salary no matter how long you live – people definitely want that.”

Tully says Government changes to the tax treatment of annuities on death also add to their appeal but that “people have been slow to pick up on this”.

Under new rules, joint-life and guaranteed term annuities will be passed on tax-free if the original owner dies under the age of 75.

Retirement Intelligence director Billy Burrows agrees that for the market to recover, the industry needs to move away from thinking of annuities as a product to sell.

He says:There won’t be a swing back in the short term but the case for annuitisation has never been stronger because most people need an element of guaranteed income. Over time annuities will come back into fashion. I feel quite strongly in the future it’s not about product, it’s about customers’ needs and wants, therefore annuities are far from dead.

“To get back to previous levels interest rates must increase. People also have to realise the importance of a guarantee and that the grass isn’t greener in drawdown.”

Tradeable annuities

This month, Money Marketing revealed the Treasury has been in talks with providers about legislating to allow the development of a second hand annuity market.

Pensions minister Steve Webb is driving the idea as a way of ensuring people who have already bought an annuity do not miss out and can still take advantage of the pension reforms being introduced in April.

Lawson says: “It will gain more prominence after 6 April when people who have annuities realise they can’t do anything with them. It might become more of a political issue then, an incoming Government might be more pressed to consider the issue seriously.

“People will be surprised at what they can get back. If you’ve had 15 years worth of income and you get three quarters of your pot back that’s good value – we believe those are pretty realistic numbers.”

Adviser view

palfrey

Craig Palfrey, certified financial planner, Penguin Wealth

Annuities will continue to have a place in the retirement market post 5 April for the simple reason that they have two unique features which are important to people – certainty and guarantees.

Time and time again when asked what is most important in considering their options at retirement, retirees cite security. Annuities provide this and for all their drawbacks, this certainty and low risk position trumps the alternatives. They may need to be modernised and the market needs to develop, but in one shape or another annuities will continue to represent a valuable option for thousands of people.

Adviser view

Mike Pendergast, director, Zen Financial Services

Annuity sales have recently fallen due to a number of issues – the increased flexibility offered by drawdown, and the low annuity rates on offer. Whilst people see the value of guarantees, the further flexibility being introduced in April will, in my view, increase the popularity of drawdown contracts. I can only see annuity sales increasing if interest rates rise, which looks unlikely in the short term. Many clients would rather draw income directly from their funds and hope that fund growth matches drawings than commit to a low annuity rate in times of low interest rates.

Expert view

devlin

I agree that we may have not reached the peak of the UK annuities market. Our view at the time of the Budget was that the market will fall two thirds to three quarters over the next two years, which is approximately 50 per cent this year and another 50 per cent next year. The market was worth about £12bn a year, so would go down to about £4bn within two years.

However, I agree that you’ll get to a lower proportion of people buying annuities but because of auto-enrolment and people savings into defined contribution plans that market will probably still grow at 20 per cent a year from a lower level.

When valuing Partnership you have to look at the embedded value of the back book and the potential for writing new business and how competitive the market will be going forward. If a lot of people pull out of the market it will become less competitive, or if very few people pull out then there’s a lot of people going for a much smaller market and it gets more competitive. What’s more important is whether they can write alternative products – they’ve already written big bulk annuities deals, for instance.

However, I don’t think the market is undervaluing these kinds of providers because the outlook for new business is still very uncertain.

We don’t think the drawdown space necessarily helps them. The competitive advantage insurers have in the annuity market goes away. There will be hundreds of drawdown/income type products out there and for example, Hargreaves Lansdown has just cut the fees on its drawdown product, Nutmeg has introduced Sipp products and the reality is you don’t need to go to an insurer to get that kind of product.

All the asset managers will launch income products, and the annuity players’ expertise – measuring longevity risk and guarantees – is diminished in the world of simple drawdown products.

Alan Devlin is director of European insurance research at Barclays Capital

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Comments

There are 14 comments at the moment, we would love to hear your opinion too.

  1. Given a choice people will not choose to lock up their money in annuities. Annuities will have to sold or missold and their demise is inevitable.

  2. @Anthony Smith: don’t agree that the situation can be generalised in this way. There will be those who can afford “not to lock up” their money, and there will be those who will not see it as locking up their money but as spending it on a worthwhile lifetime guarantee of a secure level of income. Horses for courses and annuities will continue to play their part.

  3. We are supposed to ensure we “Know our Client” and only then advise. We cannot guarantee anything except death and taxes and annuities provide a guarantee underpinned by the FSCS insurance limit rather than the investment limit.
    After doing a ful KYC, a lot of my clients end up with a combination of secure income (Final Salary perhaps and annuity) AND drawdown for the excess over essentials on their lifetime cashflow plan.
    By planning rather than order taking, we can identify what level of secure income is likely to be necessary and reach and informed decision for us first, advise the consumer/client and then my stupid service kicks in as mentioned in another posting.

  4. Having read as much as possible and been to several conferences on the topic, the consensus of the informed seems to be that annuities are far from dead – and I happen to agree.

    1. Current low interest rates won’t last forever, and the risk free return of investments will become less attractive
    2. Those about to retire in the next few years will by logic have older plans. These will need to be switched or converted to newer versions to accommodate the new proposals. Sure there will be plenty daft enough to pay the fees and charges to convert, but wiser heads will weigh it up and probably decide that it isn’t worth it and go for the annuity.
    3. Much of the assumptions are based on standard annuity ratres. Impaired or enhanced start to look more attractive
    4. Who can recall a time when a standsard annuity for a male aged 65 was x 10 base rate and now even x10 inflation?
    5. Advisers and providers are salivationg at the prospect of hanging on to the money and their income stream. But consider – the main logical impetus for this ‘freedom’ is the ability to spend or perhaps to pass down (after tax) to future generations. As far as the spendthrifts are concerned I hope they develop a liking for cat food when they get to 80. For those considering legacies I wonder how keen they will be when they discover that in order to preserve value they are going to have a lower income than the equivalent annuity can provide.
    6. If (say) a 6% income is required (Not that far adrift from an annuity which is guaranteed and whose only risk potentially is inflation) then being very conservative an investment return of 7.5% is required just to stand still and preserve capital. (After all if you blow the wad and die before your spouse – what will they do?) Markets are not that kind and the investments will need careful husbandry.

    Of course the elephant in the room is the fact that (apart from the footling AE) Government is trashing pensions for those who are serious about pension saving. Tax relief seems to be the next casualty and who know what will happen to the PCLS? In which case even those poor souls in AE will start to think twice about opting out and taking a rise in salary instead. All that will be left are those who engage in salary sacrifice who will of course still get tax relief at their highest rate. Forgoing some of the much publicised advantages of pensions which are taxed in payment – so that tax relief – for as long as it lasts – is only loaned money and some may well get reduced relief at say 30% and pay tax on the pension at 40% – not a great deal! And remember the Government is stuffing more people into HRT every year. ISAs begin to look increasingly attractive (as long as Government keeps their greedy fingers off them). Income is tax free – at a time when this is even more important. Access is unfettered – no rules – no interfering advisory services and no tax. How many families (husband and wife) fund more than £30k into pensions per annum?

  5. Stupid Service Client options advise v order taking;

    1.I advise you to do this

    2.This is one of the options I thought of, but not what I would recommend

    3.I would not recommend this, but nor would I advise against.

    4.I think you are being silly, but on your head be it.

    5. I think it a stupid idea, but I can only advise against. I will do it if you insist.

    6. You are insane, find someone else who is too if you want to do that

    The problem with Pensionwise is that it takes time to be able to get to the last one and Pensionwise will NOT be authorized to do number 6, the problem will be either they will proceed doing the wrong thing without advice, or approach an adviser who will either say their fee is insufficient to cover the risk of a complaint appearing at an infinite time in the future OR if they are stupid enough to provide an opinion for insufficient fee (I have heard advisers saying min about £600, common £1,000 for that advice) then have to charge them to tell them no 6!

  6. I think underwritten/enhanced annuities will still have their place but the outlook for ordinary, very low rate annuities hardly looks bright.

  7. The annuity question highlights how polarised client decisions are. At the one end, you have individuals who will now view their pension either as a way to get as much secure income as possible in order to have a bearable retirement lifestyle, or withdraw the lot to have one last hoorah before descending into state-sponsored poverty. At the other end, you have the lucky ones, who will look to maximise the investment/tax avoidance benefits of pensions for as long as they last.

    A valid reflection on the rich-poor divide and how different retirement lifestyles will continue to become more disparate. My view, annuities will make a comeback, for the precise reason that you cannot beat their security or open-ended nature, without paying understandably higher costs. However, I believe it will be the traditional annuity, not the new flexible model, which will reap the benefits, as the cost of flexibility will destory any value for money (compare with value protected annuities, which have never taken off). My hope is that individuals are forced out of apathy, and at least get the best possible income for themselves.

  8. @Anne – annuity – I agree, traditional annuities will not disappear, just as PLAs haven’t entirely and providers will dip in and out of the market with offerings from time to time i.e.54L and GRIP etc which will work at different times for a client in different parts of the cycle. However once a traditional annuity is purchased, that is IT, you’re done, all flexibility gone and that is why i have always argued that the at retirement advice should be about all options, ie.e. you can’t advise on annuities without considering triviality and drawdown, nor the other way round or any hybrid combination.

  9. PLAs take about £100m pa, CPAs were about £12bn pa. Lesson: when people have a choice they don’t buy annuities. This is also true in all other countries. The fall in annuities has a lot further to go.

    Looked at differently – are there any advisers reading this who’ve told clients to cash in their ISAs and buy a PLA?

  10. @Peter – I dont disagree, BUT we are advisers providing a service to clients and should reccomend the right product. If the client doesn’t end up buying the right product, then either we are not fact finding and then educating the client as to the longevity risk associated with not having adequate secure lifetime income or we are simply bad salesman.
    We are NOT order takers or customers (transactional),people will fail to buy annuities when they should without advice now, wheras to date they have been misbuying an annuity when they shouldn’t! The pendulum has just swing the opposite way.

  11. PLAs take about £100m pa, CPAs were about £12bn pa. Lesson: when people have a choice they don’t buy annuities. This is also true in all other countries. The fall in annuities has a lot further to go.

    Looked at differently – are there any advisers reading this who’ve told clients to cash in their ISAs and buy a PLA?

  12. Phil

    I’m not saying that annuities will completely disappear but the article is about whether they will have a resurgence. I’d argue they have much further to fall in volume terms.

    When it comes to the advice side and the need for guarantees my question is why annuities are so seldom recommended (or recommendations are not followed) on non-pension money in comparison to pensions: the disparity is over 1:100.

    There is also a lot of talk elsewhere that smaller pots will annuitise – I disagree there too because the poorer pensioner couple will have about £12k pa in state benefits and the small pension pot might add 10% gross to that, which will become 4-5% net once benefits are clawed back and tax is paid. Hardly worth it.

  13. @Peter – I know you’re not. I am just trying to ensure that a sensible product isn’t too rubbished by the popular press that it is removed from our tool bag of potential solutions, much as PLAs have been. I will use guarantees for clienst where needed as that is something that investment only funds cannot provide. Once you get over a certain secure income level, then the excess of capital over that doesn’t need those guarantees and can be unfettered.
    As to smaller pots, pre Pension Freedoms, I was arguing for an increase in the Trivial Pension limit to about £50k as I don’t think CPAs for under £50k were very cost effective for anyone. The flexible pension limit of £20k secure income was quiet sensible and the drop to £12k this year per person was workable too. The complete pension freedoms is going to prove problematic, but hey, that’s what happens when politicians make decisions without consultation. The irony is that the FCA tell us they can’t do anything without consultation and potential judicial challenge on issues which may take nearly 2 years, while politicians appear able to change on a whim because it is politically expedient for votes rather than the good of the country. I suspect they then justify the rushed decision on what is good for the country is they remain in power as they are best placed to make these decisions and if that means they have to rush to but votes and remain in power, the end justifies the means. Unfortunately that kind of school of thought is where Hitler and Stalin came from!

  14. @Peter – completely agree with your last point. When I worked for a provider, it was very common to get calls from customers with small annuities in payment who wanted to ‘cash their annuity in’ because it was preventing them from getting more state benefits.

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