Temporary annuities might just be the answer. I came across some killer stats on the National Statistics website which certainly helped to persuade me that they will play an increasingly significant role in the decumulation process.
First, a quick recap on where we are at and why I think temporary annuities are set to enjoy significant growth in demand.
We know that the world is turning money purchase and, in spite of the best efforts of the luddites at the TUC to preserve DB provision, within a few years the vast majority of private investors in the UK will be largely dependent on money-purchase pensions for their retirement provision.
This means that these same individuals will be obliged to contend with the uncertainties and complexities of managing the decumulation process for themselves. Many will turn to IFAs for guidance and help.
The traditional conventional annuity still has a role to play but that role is evolving. Conventional lifetime annuities are subject to a multitude of corrosive influences which are stripping away rates of return. Enhanced annuities are taking away the cross-subsidy provided by the shorter-lived investors. Solvency II threatens to pile on reserving requirements that will leave insurers cutting returns to match costs.
I am indebted to the perspicacious Mike Morrison of Axa Winterthur for his observation that the conventional annuity, far from offering an investment return, will increasingly become little more than an insurance contract against longevity. This means that the investment return element of the annuity will diminish to little more than a return of capital plus inflation.
Meanwhile asset-backed solutions, draw- down, investment-linked annuities and variable annuities will continue to grow in popularity as the yield from conventional annuities steadily diminishes. Lest anyone think that I am foolish enough to make a prediction of future annuity rates, it is also, of course, entirely possible that annuity rates will in fact shoot through the roof, propelled by the effect of quantitative easing and a sudden burst of inflation.
The numbers that really caught my eye were the ONS stats on healthy life expec-tancy. It turns out that while your average 65-year-old has life expectancy of 15 to 20 years, they have a disability-free life expectancy of only around 10 to 10.5 years. This means that half of today’s healthy 65-year-olds will be eligible for an enhanced annuity by the time they reach age 75. That being so, it seems to me unreasonable to sell them a lifetime annuity.
So, the argument in favour of purchasing a lifetime annuity now is simply that while it looks like poor value today, it will look even worse if you wait until tomorrow. The arguments in favour of temporary annuities are that changes in annuity rates in the other direction (that is, upwards) or changes in personal circumstances (that is, ill-health, or death of a spouse) are likely to lead to a higher income if the final annuitisation process is deferred for five of 10 years. If I had to take a bet, I would favour the latter arguments over the former although it is a close-run thing.
The ideal solution for those that can afford it probably lies in a mix and match solution involving partial annuitisation through a temporary annuity combined with asset backed solutions such as drawdown. I see no reason why investors cannot simply buy “chunks” of income for themselves as their circumstances demand.
I have been surprised that for the past couple of years, Living Time has been championing temporary annuities alone. Perhaps this is because the interests of many of the bigger more traditional life offices were better served by sticking with either lifetime annuities or drawdown.
In a calculation of return on capital, they were better off sticking to the game they were already playing rather than trying to launch a competing product – the temporary annuity. This does now seem to be changing though. In quick succession, we have heard flirtatious noises from both LV= and from Aviva. Both companies have let it be known that they might be moving into the temporary annuity market.
I welcome this and hope they do indeed follow through to a product launch. We are now entering the boom years for defined-contribution pensions, with tens of billions of pounds emerging from the system yearly over the next decade. The opportunities are huge and I am delighted that the market is developing more sophisticated and interesting ways to meet this surge in demand.