Over the medium to longer term, fund flows, asset class preferences and the cost of capital could all be influenced by the changes.
The aggregate pot supporting life company annuities-in-payment is in excess of £200bn. Older readers will recall the major shift in underlying annuity assets – from mostly gilts to predominantly corporate bonds – that took place in the early 2000s, and a further major shift is just beginning, as insurers and their fund managers increasingly look to invest in infrastructure projects (such as Friends Life Group’s support for the Drax power station) and to ‘step into the shoes’ of banks that are looking to slough off longer-dated commercial lending commitments that will attract unattractive capital charges under Basel III. A significant sustained reduction in annuity new business volumes would cause annuity assets to erode and lead to a potentially major reduction in insurer funds available to support industry, infrastructure and government spending.
Given that some retirement income specialists (notably Just Retirement and Hodge Life) back a substantial proportion of their annuities with equity release mortgages, the supply of home income loans could also be pressured.
On the topic of mortgages, one of the factors behind the Budget changes was no doubt a desire to provide homeowners, whose endowment policies failed to produce enough to redeem the mortgage, with the wherewithal to help them clear their commitments. This subtle political subplot (which helps out the banks) stands alongside the increased tax take that HMRC will enjoy as a result of faster decumulation of pension fund assets.
Returning to the issue of annuity funds’ size and investment philosophies, it is entirely possible that increased volumes of bulk annuity business could offset the reduced volumes of individual annuity business, as corporates continue to de-risk their final-salary pension schemes. Immediately prior to the Budget, there was talk of a bulk annuity ‘capacity crunch’ following the exits in recent years of specialist players such as Lucida, MetLife, Paternoster and Synesis.
Legal & General and Prudential write substantial volumes of individual and bulk annuities, and it would be a fairly simple matter for either of them to re-weight their annuity new business activity to write more bulk business to offset the fall off in individual flows.
In deciding how to allocate capital between different products, multi-line providers (such as Aviva, L&G and the Pru) will be mindful of their regulatory capital requirements, including the impact of reduced/maintained annuity activity with regard to diversification benefits, which might also affect decisions on whether to reinsure or retain their annuity liabilities.
The fact that the quantum of retirement-related funds held by individuals has not changed as a result of the Budget, together with the likely increased deployment of resources in pursuit of pension scheme de-risking, is generally positive for the industry and its assets under stewardship. What is more, the new decumulation regime, coupled with the Isa reforms, could provide a further boost for the benefit of insurers, platforms, asset managers and advisers, as these seem likely to spark an increase in genuine new saving – as opposed to the smash-and-grab pension transfer recycling that has dominated new business flows for many years – as investors formerly put off pensions by their complexity and the annuitisation rules, respond to the new changes by topping up their retirement savings, safe in the knowledge they will have unfettered access to them in future.
The ending of compulsory annuitisation is akin to telling travellers who formerly relied on a bus service that they are now free to own private cars and travel where and when they want. They will need the financial equivalent of driving instructions, satnavs, airbags and service stations to ensure that the in-retirement financial journey is a safe and enjoyable one. The freeing of the fiscal shackles will foster a huge amount of product innovation as industry participants busy themselves in developing, implementing and managing in-retirement flexible solutions. These will include greater use of variable annuities and other investment formats with guarantees to provide controlled exposure to risk assets, as well as solutions (including ‘regular’ annuities and, potentially, individual longevity swaps) that provide savers with benefits to help reduce the impact of potentially running out of money on account of underestimating their life expectancy.
Ned Cazalet is chief executive of Cazalet Consulting
