PensionsMar 23 2015

Where to now for annuities?

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The chancellor’s proclamation during last year’s Budget that “no one will have to buy an annuity” had predictable consequences for providers of the products, but in the year since that speech, the industry has been working on ways of making guaranteed income part of the retirement landscape.

Fourth quarter figures compiled by Towers Watson showed that sales of enhanced annuities, those sold to people with lifestyle or health factors that would reduce life expectancy, fell by a further 13 per cent to £335m, down 44 per cent over the year as a whole.

Jeremy Nurse, a director at the consultancy, comments that the reductions in sales were an inevitable reaction to people anticipating the at-retirement reforms. He did add that some stability should return to the annuities market, albeit at a lower overall sales level.

“Declining gilt yields over the second half of 2014 continued to put downward pressure on annuity rates, which has only added fuel to the fire of doubt surrounding annuities at the moment.

“Traditional annuity products, along with some of the more flexible annuity products already available and those being mooted in the market, will undoubtedly continue to suit the risk and tax considerations of many retirees.”

Fewer sales, larger pots

The Association of British Insurer’s fourth quarter statistics confirmed that drawdown has been the main beneficiary of the annuity slump, with the number of contracts sold more than doubling compared to Q4 2013. Fast falling average pot size further evidences encroachment into traditional annuities’ space.

Interestingly, the update also showed that the percentage fall in the number of annuities sold was greater than the percentage fall in the value of annuities, suggesting that people with smaller pension pots in particular are deferring or taking cash.

Rob Yuille, the ABI’s manager for retirement policy, notes: “These figures show savers with larger pension pots continuing to buy annuities, while others are entering drawdown with smaller funds than in the past.

“More people are clearly taking cash, but many are still making an active choice to buy an annuity with a small pot.”

The findings matched the experience of Vince Smith-Hughes, head of business development for retirement income at Prudential, who tells FTAdviser that the average value of annuities being sold has gone up “as people use the triviality limit below £30,000”, a trend he predicts will continue.

“No one knows how many will buy at lower values, but I suspect few will be bought for less than £20,000.”

Specific role

John Lawson, head of policy at Aviva, suggests retirees are likely to use annuities to meet specific needs through greater use of ‘variable’ options, suggesting many will use a portion of their pot to provide guaranteed income for fixed costs and take on more risk with discretionary expenditure.

“That’s certainly the way that the US market has gone, with things like variable annuities. So I think we’ll be looking at blends of the two, trying to estimate the certainty of an income stream over the course of retirement.”

Laura Perez-Martinez, European insurance analyst at Moody’s, says that insurers with subsidiaries in the US selling variable annuities could get a jump on a growing market.

“Despite some UK insurers having experience in selling variable annuities, we believe it will still take some time before they become a real proposition.

“This is because variable annuities are complex products and advisers need time to familiarise themselves with the features, plus their design would likely differ from those in the US, as regulatory regimes are different, particularly given the forthcoming implementation of Solvency II.”

Another oft-cited option is that people could annuitise for a defined period. Mr Smith-Hughes argues that along with the decline in traditional annuities, fixed-term policies will become more popular.

Mr Lawson concurs: “I can see the development of fixed term annuities to bridge the period up to state pension being payable, or to bridge the gap until equity release later on in retirement.”

Standard Life’s head of customer annuity solutions Ken McGaughey says: “I think retirees are likely to be more strategic about when they buy an annuity and who from - but over the long-term people will come back to the market.”

He adds that ‘capital protected’ annuities could be attractive, as one of the biggest problems people currently have is losing control of their capital upon death. He cautions that such add-ons inevitably come at an extra cost.

On the flip side of the timing argument, the pensions minister is keen on annuities deferred until later in retirement and even being used as a default for pensioners at a certain age, so-called ‘later-life annuities’. However, provider research has found a distinct lack of demand.

Mr Lowe comments that it is “beyond people to think that far ahead, that’s what the research shows, so we haven’t built anything”. He adds so far the Treasury has not given tax law freedom to develop such structures and most people’s pension pots are not big enough to buy them anyway.

Evolution, not revolution

As the pensions minister Steve Webb alluded to recently, while innovation in this space is a certainty, it is likely to be over the coming years, rather than months. Andrew Power, partner at Deloitte, echoes most providers in expecting genuinely new products next year at the earliest.

“Firstly, it is very unclear what the public will do in response, most surveys point towards people liking many of the features of annuities, e.g. guaranteed income, but not the product itself. Secondly, many providers systems will get in the way of introducing flexible products.”

Andrew Tully, pensions technical director at MGM Advantage, agrees annuities are suffering from an image problem at the moment.

“Our own customer research suggests that if you remove the name, the description people give of what they want in retirement has many of the features of an annuity. However, most do say that they want to have more flexibility, so we’re looking at giving them that through combinations of product features.”

Stephen Lowe, group external affairs and customer insight director at Just Retirement, says his firm also undertook extensive research following last year’s Budget, finding that amongst other things, framing conversations is really important.

“Once everything else is secure, people want a flexible pot and rather than putting it in a cash account, this is a drawdown platform with a simple range of passive, low-risk funds,” he explains, describing the solution his firm has come up with.

“[Then] 10 years down the line this flexi-fund would then be used to balance the inflation impact on getting a guaranteed income. The other use of the flexi-fund is of course for infrequent and un-planned expenditure.”

Legal and General’s distribution director David Pope commented that April is only the starting line, so while development is already underway, “like most other providers we’re waiting until we get an idea what happens with the first wave before we bring anything to market”.

A spokesman for Friends Life added that opportunities exist to develop new flexible annuity solutions such as short-term annuities, longevity insurance and value protected annuities.

peter.walker@ft.com