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?
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.
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.
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.”
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.”
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.
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.
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