Key points for individuals:
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Annuities have had a bad press, but for many they are still the best way to guarantee an income for life
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Due to historically low bond yields, at face value selling on annuities may look like a way to cash in on a windfall (see table 1)
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The reality is that buyers will require a risk margin to reflect the uncertainty of how long the person will live. And underwriting and administration charges will be deducted – so it’s not as good a deal as it may at first seem for the individual
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However, the ability to sell on annuities should increase the appeal of buying annuities in the first place
How will a market develop?
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The government has said annuity holders won’t be able to sell their annuity back to the provider. It has also stated that second hand annuities won’t be an appropriate investment for retail investors due to the difficulties in determining a fair price. We agree that the dynamics are too complex for retail investors.
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A secondary market will need to emerge. It will be a challenge to get this up and running.
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It would need to be run by aggregators – a party that bundles all the annuity contracts together and sells shares in the portfolio back to investors. This could create an opportunity for investment banks
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The biggest buyers will be pension schemes and insurers looking to match particular income flows or longevity characteristics
The key questions that need to be asked as part of the consultation are:
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How will ‘advice’ be delivered? It’s difficult to see how individuals could sell their annuities without advice. Guidance will not be sufficient.
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What protections will be put in place for consumers?
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How will life expectancy be assessed on an individual basis? There are problems with the accuracy of ONS data, particular for older people, and medical evidence would need to be gathered
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What will be the impact on the state if individuals cash in and find themselves living longer than expected?
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How much of a tax windfall will this be for the government?
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The government has announced that it will allow more than 5 million people who have already bought an annuity to trade in their policies for cash. This will be hugely complicated, says Hymans Robertson, the independent pensions and risk consultancy. As such it calls for the current, or any subsequent government, to carefully think through the detail and avoid rushing the policy through, as the consequences, both in terms of consumer protection and impact on the insurance industry, could be considerable.
Commenting Douglas Anderson, Partner at Hymans Robertson, said:
“This reform will be welcome news for insurers who manufacture annuities as they approach the 6th April. The ability to sell on should increase the appeal of buying annuities in the first place. This is a much needed boost given the sharp fall in interest rates since the turn of the year.
“This will be an appealing policy to many pensioners who feel trapped in a product they didn’t want to buy. However, individuals need to carefully consider giving up their annuities. If looking for a guaranteed income to last your life then an annuity is hard to beat. Our research shows that women underestimate life expectancy by 8 years and men by 5 years. This gap between the perception and reality could have significant consequences in the context of this proposed reform. Annuities have had a bad press, but for many they are a good, if under-appreciated, option.”
Commenting on how the market might work, he added:
“Creating an open, secondary market for selling on annuities is no small undertaking. We think it could have similarities to the secondary market for mortgage endowment policies and the US life settlement market. To deliver confidence in this new market, lessons need to be learned from the past.
“New investors would offer to buy second hand annuities, probably through an intermediary – think of ‘we-buy-any-annuity.com’. Some providers may also wish to offer a surrender value, but a secondary market will exist.
“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 old 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. An efficient process for this will need to emerge.
“In terms of the mechanics, we would expect to see aggregators to emerge that bundle similar annuity contracts together into generational buckets. The bundling process makes the return to the investors more predictable. The investment is more valuable if upward longevity trends continue, so it would offer a good hedge for longevity risk in final salary pension funds. The longevity component could even be stripped out and sold on to reinsurers who have a growing appetite for buying UK longevity risk.
“One potential issue is that there is a shortage of good data on longevity, particularly for the oldest retirees. Last year the shortcomings of ONS mortality data for the oldest old were well documented – when the ONS revised down the numbers over age 90 by 15%. There is a need for more accurate data that is updated annually, rather than every decade, as is the case with ONS. This will be an essential building block to allow for the efficient running of a market in traded annuities.”
Commenting on the likely buyers, he concluded:
“The unusual shape of this new asset could appeal to several investors including investment banks, insurers, pension funds, hedge funds and private equity. Pension funds and, ironically, life insurers look like the natural buyers because of the longevity hedge. The different tax statuses of insurers and pension funds could affect the price they are able to offer.
Looking at how much an individual could get from selling their annuity, he added:
“The 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. The table below shows what those in good health with a level, single life annuity (i.e. with no spouse protection), could receive if they were to sell their annuity back to their insurer. This is the value before investors’ margins and administration charges are deducted.”
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