Discussing the Treasury’s announcement that from 6 April 2017 the Government will be allowing the 5 million existing retirees with annuities to sell these on, Hymans Robertson looks at the implications for individuals and the hurdles that need to be overcome for an effective market to be established.
Douglas Anderson, Partner at Hymans Robertson, said:
“It’s been trailed for some time, but the Treasury has now confirmed that over 5 million existing retirees who wish to take advantage of freedom and choice by selling on their annuities will be able to do so from April 2017, and in the process only be taxed at their marginal rate for the sale.
“While this will appeal to some pensioners who feel trapped in a product they didn’t want to buy, they need to carefully consider the consequences of giving up a guaranteed income to last to the end of their life.
“Creating an open, secondary market for selling on annuities is no small undertaking. The administration of this will be incredibly complex.
“The surprise in the Treasury’s announcement is the fact that the providers of policies will be able to buy these back from policy holders. This will definitely make it easier to establish a more competitive market as the original providers may be able to offer better terms due to the expense and capital savings of cancelling the original policy. It’s reassuring that it won’t be open to retail investors, as the dynamics are too complex, particularly due to the difficulties in determining a fair price.”
Discussing how a market might work, he added:
“We think it could have similarities to the old endowment policy secondary market, but with much more complexity. The insurer providing the annuity would provide an annuity surrender value, but a secondary market will exist where third parties, for example, other insurers and pension schemes, will compete to buy specific policies.
“The big difference between an annuity and an endowment policy is that the health of the individual has a considerable impact on the value of the annuity. For example, the value of an annuity for a 70 year person with a terminal illness will be substantially less than the value the same annuity for a healthy individual. To allow for this, the market for annuity purchase will need to factor-in underwriting costs.”
Commenting on the Government’s plans to consult with industry and the FCA to create an online tool to help consumers work out an estimated value of their annuity, he added:
“In principle this is a sensible idea. The biggest challenge here will be capturing health data to arrive at sensible life expectancy assumptions on an individual basis. This will be key to arriving at a fair price. Accurate life expectancy data is an essential building block for the second hand annuity market to work effectively. Doing this in an efficient and economical way, especially for low value annuities, will be the challenge for the industry. Perhaps lessons can be learned on simplified underwriting used within the protection industry.”
Commenting on the advice threshold Treasury should set, he added:
“It’s encouraging that Treasury will compel the FCA to put in place safeguards to ensure people take appropriate advice before selling their annuities, but it will be interesting to see what it deems to be ‘appropriate financial advice.
“In our view the process needs to be advised – particularly for those with higher value annuities. The current threshold for advice for DB to DC transfers is a value of £30,000, but this may need to be lower for individual annuities due to the higher ages and mostly level benefits, meaning it is a significantly higher income being given up for a £30,000 value. Selling on an existing annuity policy is a bigger deal than deciding not to buy one in the first place. There is a definite advice gap for those approaching or at retirement already, and the failings and low take up of Pensions Wise have been well documented. It’s difficult to see how Pensions Wise can give existing annuitants the support they will need around the decisions they may now be tempted to make.”
Discussing the future of annuities, he added:
“Annuities have had a bad press. The reality is if you’re looking for a guaranteed lifelong income they are impossible to beat. We need to remember that men underestimate how long they will live for by 5 years and women by 8 years. There’s a very real danger people will run out of money at some point in retirement.
“Looking forward to the future we believe annuities will see a resurgence, but in a different form, at a different point in retirement and for smaller proportions of an individual’s retirement pot. In fact, the ability to sell on annuities may actually increase the appeal of buying annuities in the first place. Essentially an annuity is an insurance policy against running out of money. In the context of rising life expectancy and the uncertainty around it, individuals need to see it as such.
“In practice this may mean planning to gradually drawdown 85% of your pot, leaving the other 15% invested to purchase an annuity when the time is right; potentially using a deferred annuity to provide certainty of basic income in later life.”
Looking at how much an individual could get from selling their annuity, he added:
“Due to historically low bond yields, on the face of it, those trading in annuities could benefit, as investors are willing to pay more for the future cash flows. In the past 5 years, 10-year bond yields have fallen by 2.3%, which has contributed to the increase in the value of annuities.
“This bull market in bonds means that annuitants who bought five years back could get back as much as they put in, despite having drawn an income for those five years, in theory. However, as much as 20% could be wiped off this value due to underwriting and other costs. This is because buyers will require a risk margin to reflect the uncertainty of how long the person will live, so underwriting and administration charges will be deducted – so it may not be as good a deal as it may first seem for the individual.”
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