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The going rate

During the first quarter of this year there were many gloomy predictions as to the speed and size of the “inevitable” decline in annuity rates.

Quantitative easing significantly increased these fears and there was talk of rates falling by anything up to 15 per cent in just a few weeks.

Quantitative easing was designed to lead to falls in short and longer-term gilt yields and then to spread into the private sector of corporate bonds and mortgages but what occurred was different. The fall in longer-term gilt yields was halted as the level of new gilt sales to support Government borrowing over the next few years became clearer.

We saw a gilt issue not fully sold and longer-term rates increasing. Longer-term corporate bond yields have fallen meanwhile and a more realistic market view of risk of default is becoming prevalent.

But annuity rates, while reflecting the overall increase in corporate bond yields, have never reflected the extreme position because reserving needs to increase if yields indicate the likelihood of default. Therefore, they are not delivered to the retail annuity rate.

In the last couple of months we have seen relatively stable annuity rates with top conventional rates around 10 per cent lower than summer 2008, which were at six-year highs.

With margins in the mortgage and corporate bond market still in general unlikely to shrink to anywhere near pre-credit-crunch levels, the non-Government yields are unlikely in the near term to bring annuity rates down while Government yields will, if anything, not only compensate in any downward pressure in the private sector but could move the annuity yield upwards.

What is likely to happen to annuity rates now? Over the coming months, it seems likely they will remain relatively stable. The probable slight upward pressure from gilt and bond yields will be compensated by the longer-term requirement to reduce rates due to longevity experience in relation both to current annuities being written and to the need to support under-capitalised older books, meaning annuity companies will be keen to sustain 2008 margins.

Looking into next year and beyond, the main indicators on rates are continued improvement in longevity causing downwards pressure, although it must be remembered that as the retirement lifetime gets longer, the proportionate effect of improvement in longevity reduces. For investment returns, long-term gilt yields are unlikely to fall while supply is at historically high levels.

The further we go into the future, the greater the possibility that policymakers in high-debt countries, including the UK, will find the attractions of relatively high single-digit inflation too much to resist and this will potentially put additional upward pressure on yields just as the borrowing requirement itself should be declining.

Concentrating on the impact of the investment return on annuity rates is necessary at this time. Markets are volatile and are responding to almost uncharted scenarios.

Are annuity rates going up or down? Should I buy an annuity now or later? What is the risk of my losing income in the future even if my fund value recovers?

These are the most frequently asked questions and the answers have become increasingly complex. If the analysis is broadly accurate, then annuity rates will not change significantly during the remainder of 2009.

The only downside that may affect the wealth of healthy clients is that the spread between the various socio-economic postcodes is already more than double what it was when postcode annuities were launched.

This does mean healthier and wealthier annuity rates are becoming lower than they would otherwise have been and this is something that we need to tell clients.

With rates not altering much, the circumstances of the client become key. Do they require income? Are they fully retiring? Has their fund “benefited” from automatic lifestyle risk profiling? Is their fund principally invested in with-profits and reaching a market value reduction- free maturity date or has it been linked to the declining values in equity markets in the last year or two, in which case a period of contented investment to ease some recovery would be helpful?

A client’s attitude to risk on the annuity rate may mean, where income is not a minimum requirement and fund values have not been significantly depressed, that locking into today’s annuity rate and reinvesting income either in pension or other tax-efficient savings would be appropriate.

The availability of enhanced or impaired life rates, either for the annuitant client or their partner, also has a radical effect on the appropriateness of timing. Advisers need to be aware that enhanced and impaired life rates, partly due to their shorter term, are affected differently by investment conditions.

Companies are continuously reviewing the level of enhancement they will give to certain conditions, particularly those where there is growing evidence of effective treatment. Timing could often be a balance between advances in medical treatment and changes in prognosis.

In today’s market and probably for the remainder of 2009, the principal driver to buy now or to defer will relate to where the pension fund had been invested and what damage had been done to the value in the recent past.

One wrinkle to always remember in addition to this is that the value of guaranteed annuity rates is huge, often adding the equivalent of 50 per cent to the fund’s value, and may not be available on a deferred basis.

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