Take annuities. Insurers normally hold at least a proportion of assets backing their annuity books in the form of corporate bonds. Yet despite a sharp rise in AA corporate bond yields since 2007, annuity rates have failed to follow these yields north. There are two reasons for this.
Insurers might have increased the proportion of long-dated gilts they hold. Unlike corporate bonds, the yield on these has fallen. Or they might have increased the assumed rate of corporate bond defaults, which has the effect of bringing down the nominal yield.
If you believe everything you read, people should lock into annuity rates today (despite fallen fund values) as the expectation is that corporate bond yields, and thus annuity rates, will fall. That may indeed happen but if corporate bond yields do drop, then one reason why might be that the risk of default has receded. In that case, insurers might reduce their assumed rate of default, with the result that the post-default yield could be the same or perhaps even higher than before.
We also know that the Government plans a massive gilt issuance of £146bn this year. Economic theory tells us that when the supply of anything goes up, then the price will fall unless demand also rises by a similar amount. If demand for gilts does not rise in line with supply, then prices will fall and yields will rise.
These arguments about the potential direction of corporate and government bond yields put the counter view to those already publicly espoused – hold off buying an annuity until tomorrow because the rate will go up.
I have no inkling of how bond markets might pan out this year or next for that matter. Nor whether yields will rise or fall and whether annuity rates will follow. Therefore, in my view, recommending that customers time the market in the way that some are suggesting could be asking for trouble.
If timing markets was that easy, we should all have got out of equities and into cash last May. However, people could not call the equity market then, so what makes people think they can call the bond markets now?
If possible and affordable, customers should delay taking big decisions until the future is more predictable. A plan that meets short-term needs while keeping options open is preferable to painting oneself into a corner.
For those approaching retirement, there are a range of options available depending upon how much savings they have within and outside pensions and any other sources of income. For example, from a defined-benefit pension or from working. Before we push customers down any track, today more so than at any time I can recall, we should first consider the full imaginable range of what-ifs.
John Lawson is head of pension policy at Standard Life