Your IndustryMar 26 2015

Barriers to annuity-for-cash plans

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A paper was published alongside the Budget that pledged to push ahead with creating an annuity re-sale market.

The government’s desire to push ahead is understandable: more than 5m legacy savers, probably not content with their existing income stream, could be keen to have a cashing out option. The concept of freedom also lends itself to offering an open market solution.

However, experts picking through the content of the paper found it produced more hurdles than solutions as to how this market would operate.

The basics

The consultation paper stated the government, if re-elected, will legislate that from April 2016 to allow people who are already receiving income from an annuity to agree with their annuity provider to assign their income to a third party for a lump sum or an alternative product.

A 55 per cent tax which would currently apply will be removed in favour of the marginal rate taxes applied to other savers when access their pension flexibility from next month.

It is worth noting the right to assign will not be extended to those receiving a pension from an occupational scheme and experts warned the difference between this and having an annuity may not be clear to all.

Also, a key piece of phrasing in the draft rules states the existing provider will need to agree to re-assign the income, essentially allowing firms to block re-sales. Aviva, Scottish Widows and Phoenix were named in a Sunday Times article as unable to confirm they would agree.

Advice need

In the 35-page consultation paper the government admits safeguards will be required to stop annuitants losing out once they are allowed to sell on their policy.

The paper argues there is a strong case for requiring annuity holders to take financial advice from an independent financial adviser prior to making the decision to sell, with a requirement for annuity providers to check this before they enable the annuity to be assigned.

This mirrors the requirements now in place for when people convert from a defined benefit to a defined contribution based pension during their accumulation phase, where the value of the pension is above £30,000.

The paper states: “Regulated advice would ensure that individuals receive help tailored to their circumstances and a recommendation on whether assigning their annuity to a third party would be in their best interests.”

It says people would still be at liberty to choose not to accept a recommendation. It also notes regulated advice “can be expensive, as individuals could have to pay several hundred pounds or more, which might be a significant proportion of the value of their annuity”.

However, the government argues following on from the FCA’s recent clarification of rules around simplified advice and new business models for online and telephone advice, there are new, expanded opportunities for the advice sector to meet the growing demand.

‘Buy-backs’

Elsewhere the consultation also seemed to rule out annuity buy-backs by the original insurer, which it is feared could be a source of detriment and could undermine the competitive market that the reforms hope to create.

The government believes that the risks of allowing ‘buy-back’, effectively terminating the contract, outweigh the benefits, but added it “welcomes views on the potential risks and benefits of allowing ‘buy back’”.

According to the paper produced by HM Treasury, allowing annuity providers to ‘buy-back’ their annuity could also result in some consumers falsely believing that they can only use these new freedoms through their existing annuity provider.

Martin Tilley, director of technical services at Dentons Pension Management, questions who would want to buy. He says purchasers of annuity contracts other than pension schemes will face tax implications on future annuity receipts meaning the income stream they will receive will be far less attractive.

Mark Stopard of Partnership also told FTAdviser this option could be vital if the market is to work for smaller pot savers, as the tax implications could make this income stream unattractive for third parties but still valuable to the original insurer, which is effectively writing off a liability.

Who will buy?

The need to undertake health assessments on each individual to enable underwriting, coupled with the costs of administration, it is likely the cash lump sum price for a given annuity will be significantly less than the original purchase price, less any payments that have been made to date.

Many have predicted discounts will be applied of around 20 per cent; some have even claimed these could be higher.

Mr Tilley says such concerns, coupled with the lack of index-linking on most policies which brings additional future liabilities, mean one of only a few likely buyers might be pension funds.

He says: “So the question is, who is going to be in the market to buy these schemes? In reality, very few, which will mean the market may not be as competitive as the government hopes and those that are, will be buying on their terms, which will be slanted in their favour.”

Mr Tilley adds IFAs will probably not want to provide advice on annuity re-sale, as specialist knowledge would be required and the likelihood of a positive recommendation “must be slim.”

Steven Cameron, regulatory strategy director at Aegon, says: “We fully expect individual underwriting to be required because buyers won’t be able to offer a price without information on the individual’s life expectancy.

“This makes providing benchmark selling prices or shopping around before you sell problematic – each prospective purchaser might demand their own medical evidence. For joint life annuities, both partners may need to provide medical evidence.”

Who will sell?

Serious questions were raised as to what individuals would be best advised to sell their annuity.

For customers choosing between drawdown, cash and annuity purchase in the future, Steven Cameron, regulatory strategy director at Aegon, says the creation of a re-sale market does not changes the respective merits of each option “to any significant extent.”

Mr Cameron says: “Annuity assignment is unlikely to be appropriate for the majority of annuity purchasers and those purchasing an annuity shouldn’t be doing so with the intention of assigning at a later stage.

“It is good to see the government making clear that they consider most individuals will be better retaining their annuity.”

It is worth noting the government has projected to make £1bn in marginal rate taxes from the policy in the first two years, meaning that while it states most should not take advantage, it is expecting as many as 100,000+ people a year initially to sell up.

Mr Cameron adds that joint life policies in particular need consideration. “Unless all dependents are party to the agreement, we are storing up shocks for widows and widowers who might otherwise not know their deceased partner has cashed in their future income too.

“This could be another area where women suffer – they already on average have lower private and state pensions. For joint life annuities, we can’t see how assigning only that part of the annuity paid to the main life can be made workable.

“The risk of consumer detriment here is arguably higher than with any other retirement decision.”