“No one will have to buy an annuity,” the chancellor George Osborne said. We understood why this was a political win. Annuities have been a mainstay of pension decumulation for 60 years, and achieved their objectives – to make pension savings last life-long. Since the credit crisis, sustained low interest rates and low to negative real yields have hit savers, including annuitants, in low risk assets.
We improved annuity pricing for the customer by 13 per cent last year, but the damage had been done. Quantitative easing – a policy invented by the rich for the rich – created winners from asset price inflation and losers from low yields. Losers included those who had to buy an annuity. Macro-economics, not the product or the industry, was what made compulsory annuities unpopular.
We think it is fair to open up choice for consumers, to let the market flourish. People should be allowed to choose what they do with their money, and this will affect the market and the wider economy.
We expect the individual annuity market, currently worth £12bn in annual premiums, to split three ways between full withdrawal, annuities to provide certainty of income, and drawdown and new products.
One driver will be pot size. Small pots, less than £10,000, will probably be cashed in. Annuity premiums from pots between £10,000 and £30,000 currently deliver £2.2bn in annuity premium, but will only produce £0.4bn in future as they will be split across cash, drawdown and annuities. For pots above £80,000, we expect a reduction from £5bn of annuity premium to £1.5bn, with drawdown a major beneficiary. And if you have a short life expectancy, you are also more likely to take cash.
We estimate the likely 2015 sizes of the cash, annuity and drawdown market segments at £4.9bn, £2.8bn and £5.8bn. Reality for individuals will be more complex, as some will take a mix, or use different products at different times.
The government knows freer choice requires good advice to help people make better-informed choices. This advice question is a far bigger challenge for the market and the government than the issue of product development or adaptation.
Guidance and advice – small and capital ‘A’ – must be available and must be good, without creating an open-ended liability or cost for the industry. Advice given at retirement is fine, but what if more is needed later as the ideal product mix changes? For adviser and customer, it will be about hitting a moving target as retirement progresses.
There will be new drawdown-type decumulation product opportunities. These may allow savers to enjoy some of the capital appreciation that so helped the wealthy under QE, instead of being stuck with low yields from annuities. But there is more risk and people need to take care. We expect to see an increase in new drawdown-type products. From a provider’s perspective, these will be lower margin, but less capital intensive.
Speculation
There has been speculation about newly liberated defined contribution pensioners swarming into the buy-to-let market. The £1 trillion of housing equity already owned by pensioners is actually more important.
More of this should be put to productive use by creating attractive ways to right-size pensioners’ balance sheets, raising incomes and improving quality of life. This means equity release and more building for older people to help correct 25 years of intergenerational unfairness in housing.
Freedom in decumulation must drive more saving. It will become clear that however much choice you have, you can still only take the money out once. Over 60 per cent of all annuity pots – over 200,000 policies annually – are smaller than £30,000.
So we simply do not save enough for retirement. This will improve now the incentives to save have improved. Our research suggests DC should grow at 12 per cent a year, and we also expect growth in Isas, unit trusts and retail savings on platforms, pension savings in DC schemes, and workplace pensions.
DC fund management opportunities will expand, which is good for some providers.
Individual annuities will remain right for many people at different stages of retirement, and with the continued secular expansion of the bulks market, some providers expect to write more annuity business in 2014 than in 2013.
There are £1.1 trillion of assets and £1.8 trillion of liabilities in private sector defined benefit funds. This is a market where structurally a huge amount of de-risking is still required through a growing bulks market, longevity insurance and liability-driven investment (LDI).
BPA is a product for DB schemes, so we should consider what the Budget might mean for DBs.
The Treasury’s consultation asked whether the new freedom for DC pensions should be made available to private sector DB scheme members, by simply allowing them to transfer into DC schemes and then extract their money as they like.
The government has already prevented members of DB schemes transferring into its own funded DC schemes, worth around £210bn, and rightly so, as there could be customer detriment and damaging macro-effects from uncontrolled DB outflows.
For example, encouraging members to head for the exit could be seriously disruptive to markets, including gilts and corporate bonds.
I believe the government will opt for a restrictive approach that allows very limited exits from DB – such as, only for those schemes that are in surplus.
DB schemes will have to continue de-risking through LDI, longevity trades, BPA, buy-ins or buy-outs. So if you are in bulk business, LDI business, and the longevity business then rumours of the demise of annuities are exaggerated.
Nigel Wilson is group chief executive of Legal & General
Key points
* Macro-economics, not the product or the industry, was what made compulsory annuities unpopular.
* Advice given at retirement is fine, but it will be about hitting a moving target as retirement progresses.
* Retirement saving will improve now the incentives to save have improved.
