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The price of longevity

Increased longevity inevitably means lower annuity rates and the challenge is to develop an easy-to-understand asset-backed annuity By Lee Jones

The basic mathematics behind retirement income dictates that the longer a person is likely to live, the lower the annuity rate they are likely to receive from a provider. But what is going to happen to annuities as more Brits live longer?

According to the Office of National Statistics, the percentage of the population aged 65 and over increased from 15 per cent in 1983 to 16 per cent in 2008, an increase of 1.5 million people. In 2007, the number of people in the UK above state pension age exceeded those under 16 for the first time ever, according to the Department of Work and Pensions.

The increase in longevity is expected to continue increasing and the ONS says that by 2033, 23 per cent of the population will be aged 65 and over and the number of British centenarians is expected to rise from 12,000 today to more than 280,000 by 2050.

This trend directly correlates with the deterioration of annuity rates. According to figures from William Burrows Annuities, average rates have roughly halved from more than 15 per cent at the end of 1990 to less than 7 per cent by 2010.

LV= head of annuities Matt Trott says: “An annuity is an insurance policy, you are insuring the financial affect of living longer than you expect, that is the game that providers are in. Longevity is core to that.” So, what will happen to annuity rates as Britons get older?

Aegon pricing and capital managing dir-ector Richard Priestley says providers will inevitably be forced to offer lower rates to people who may have 35 or 40 healthy years in retirement.

Priestley says: “As people do live longer, the amount of income they get from a fixed pot will go down.

The challenge of bringing about a change in financial habits is daunting. Longevity isn’t a choice for Britain, it’s a certainty. The question isn’t whetherwe pay for it or when but how we start to pay for it now

“We price annuities by taking money from the client, invest it and then provide an income with a plan that the assets will run out the day the client dies – so the longer they live, the less you can afford to pay them. There is no magic in pricing annuities. As people get older, rates we can offer will fall.”

Legal & General head of product development for individual annuities Tim Gosden admits this will obviously turn people off taking a lifetime guaranteed product. He says: “As a result, providers will have to start looking at more asset-backed annuities.”

But as Trott points out, this will create a problem, particularly for people with average or smaller pots, as many pensioners look for security and risk avoidance.

He says: “Investment-linked opportunities give you the potential for higher income levels but that comes at a risk. If people have a small pot, you might find they are not willing to take risk if things are going to be tight enough so they will favour the annuity purchase.”

Gosden admits that products such as with-profit annuities and unit-linked annui-ties are riskier, which makes them unpopular with holders of smaller pension pots. “People with smaller pots do not want to consider risk but in the future that will have to change.”

He says this inevita-bility may bring opportun-ities for the provider which can offer a simple, transparent index-linked annuity that offers the sort of rates pensioners will need.

Gosden says: “The big challenge is to develop a product that is investment linked but is very simple to understand, where all the mechanics are hidden behind and on the face of it you have a simple product for the adviser to sell to the customer.

“So far, I don’t think anyone has cracked that in the mass market. I think it can be done but it is a real challenge.”

While it might be that clients will be looking to insurers to be more innovative and do more with their money for longer, all agree that the ultimate onus is on the saver, not the provider, to simply save more money. Trott says: “People have simply got to have more money saved, it’s not about providers improving the annuity rate process.”

In Aegon’s recent Pensions Manifesto, UK chief exec-utive Otto Thoresen issed a warning to the new Government. He said: “It is a sad fact that there are around 9.6 million working people, half of all people in work, saving nothing at all to meet the costs they are likely to face in their later years. The challenge of bringing about a change in the financial habits of such a large group is a daunting one.

“Longevity isn’t a choice for Britain, it’s a certainty. The question isn’t whether we pay for it or when but how we start to pay for it now.”


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