Could the creation of a secondary market in annuities be good news for retirees who bought guaranteed lifetime income products in the past? There are obvious pros and cons but on balance we support the idea as a logical extension of the “freedom and choice” agenda.
Annuities offer unique benefits to individuals grappling with investment and longevity risk. As things stand, if you want certainty you have to accept a degree of inflexibility. In many cases this is a price well worth paying for financial peace of mind.
But we can’t ignore the fact that people’s lives do change after retirement and there may be occasions when people may want to make adjustments to the benefits they have selected. To help them we should extend the same choices to existing retirees as April’s reforms will deliver to future ones.
And it is possible. Our view is that the creation of a market where annuity contracts can be traded has the potential to maximise value to customers while maintaining financial stability and encouraging innovation. This could be achieved with minimal changes to current legislation and market practices.
Given the right conditions we believe a range of providers would find it attractive to join in, offering customers competitive deals – reconfiguration of benefits and cash lump sums are the obvious customer needs to be satisfied.
Most annuitants will be better off sticking with what they have. The need for a secondary market reflects the fact that there are pockets of value, a small but significant minority who would switch to a better option but who are locked in to what they have.
A simple case might be where someone with one type of annuity wants to reconfigure benefits in some way, such as adding dependant’s pension or rethinking death benefits. Even if they have to give up some income to make the switch, they may prefer to because they ultimately end up happier with their benefits. There will be other cases where having cash will meet a real need more effectively than an income stream.
Perhaps a less obvious example is for customers offered a Guaranteed Annuity Rate which has a generous level of benefit compared to current annuity rates but often demands compromises on how that income is delivered. Accepting the GAR and trading the policy in the open market could deliver by far the best outcome. Introducing competitive tension into this transaction would, we believe, drive a better outcome for the customer.
Without professional financial advice, people find it hard to properly assess the true value of such safeguarded benefits. Many people accessing defined contribution savings choose to take the maximum tax-free cash, not fully realising that they are giving up a high level of guaranteed return. Reforms in April allowing far more cash to be taken will exaggerate this problem. The creation of a secondary annuity market would offer commutation terms that properly reflect the value of the GAR.
A broader benefit would be that, just as giving people more freedom to take pension money encourages more engagement with pensions, allowing annuitants the freedom to trade in policies that are no longer suitable is likely to give them more confidence to buy annuities in the first place. Rather than shunning annuities and shouldering risk they might not be able to afford to take, they would be comfortable guaranteeing at least a core of income against future risks.
We think it would make the industry stronger too by offering a new asset class that could better offset liabilities than buying gilts or corporate bonds, which itself would encourage competition and innovation from companies keen to get involved. A secondary market could provide fair value by allowing sellers to see exactly what bids are on the table.
There would be a few hurdles to overcome although none are insurmountable. Most obviously, the law would have to change to make annuities assignable. At the moment, it is in the annuitants’ interests to make sure their annuity company knows they are still living so that income payments continue to flow. There would need to be some protocols and agreements between insurers for tracing the existence/death of those annuitants who have sold their policies to third parties.
Specialisation to meet the needs of a segment of customers is a powerful force across all businesses driving better outcomes. There’s no reason to restrict April’s “freedom and choice” pension reforms to future retirees – we should offer it to existing ones too.
Stephen Lowe is group external affairs and customer insight director at Just Retirement