What future for annuities?

Annuities, so the consensus quickly went, were dead in the water. The products were unpopular and people would be eager to take control of their pensions once new legislation made it easier to do so.

But where does the chancellor’s so-called ‘pensions revolution’ really leave annuities? Will there still be a market for them and, if so, what will it look like?

All the research points to continued demand for guarantees of the kind that only annuities can presently provide. Deloitte, for example, found that 59 per cent of savers aged 50 or over picked out a ‘guaranteed income’ as their pension priority.

Similarly, research published in January by the International Longevity Centre found that 75 per cent of DC members aged 55 or over “would prefer a secure guaranteed income over an income that might rise or fall depending on financial markets”.

The reputation of annuities has suffered a few dents in recent years, with its shortcomings exposed in a series of reports and investigations. The FCA is still on the case, launching a competition study in February on the back of a review that confirmed the market still wasn’t ‘working well for consumers’.

The problems in the market have undermined the link between the desire for a guaranteed income and the demand for annuities, according to Rachel Vahey, an Edinburgh-based independent pensions consultant (and formerly of Aegon).

“Survey after survey has shown there is a clear demand from customers for the certainty of a guaranteed income and the security that gives them in retirement,” she says.

“However, ask people if they want to buy an annuity and they are less keen. People dislike them, and the financial straitjacket they represent.”

Over exaggerated

She believes the demise of annuities has been exaggerated, however. So too does Alan Dick, financial planner and principal of Forty Two Wealth Management. He also agrees that the product has a serious image problem to overcome.

“It is interesting to note that when framed as a guaranteed income for life, people like them. However, when specifically called an ‘annuity’, people hate them.”

While there’s no doubt that annuities will remain a key part of the pensions landscape, their role will change. Phased or blended purchasing will become more prominent, with retirees using just some of their pot to buy an annuity or opting to annuitise much later in their retirement.

Mark Stopard (CORR), head of product development at Partnership, says: “The increased freedoms allow people to design the type of retirement that they want and use annuities for a variety of purposes,” he said. “We may see people manage their pension investments into their 70s before annuitising, or annuitising part of their pot in their 60s and the remainder in their 70s.”

With changing needs will, eventually, come innovation. New products may seek to exploit the option to reduce the income in future and allow people to draw an income to meet their own lifestyle requirements, says Mr Dick.

“Annuities will need to adapt to fulfil this,” he continues. “We may see more of a retirement portfolio approach with an annuity providing a basic level of guaranteed income with flexible options such as drawdown on top.”

There will also be a significant increase in individually underwritten annuities, putting pressure on traditional annuity rates.

Indeed, the standard annuity may virtually disappear, with annuities instead being sold on the basis of the customer’s health and lifestyle.

The most common type of non-standard annuity is arguably an enhanced annuity and that market may flourish if Pension Wise helps raise awareness of the open market option.

“We envisage that as more people shop around and – as part of the second line of defence – are told about these products, the market will grow,” says Mr Stopard. “Whether other types of annuities will become popular remains to be seen but with more freedom to do ‘want you want’ there is a real potential for growth.”

That may apply to with-profits annuities, particularly where there is a conversion option allowing the individual to convert (with their incumbent provider) from their with-profits annuity to a conventional annuity at a point of their choosing in the future.

“This gives the client the opportunity to have a second bite at the cherry when interest rates and annuity rates may be at a significantly higher level. It overcomes the once-in-a-lifetime annuity rate and is very attractive,” argues Brian Steeples, managing director and chartered financial planner at The Turris Partnership.

Currently, however, relatively few providers offer with-profits or unit-linked annuities that have conversion options.

“The annuity marketplace is now screaming out for innovation and that challenge is squarely placed at the door of product providers,” Steeples concludes.

Seconds out

There will soon be another annuity market for savers to think about. As if last year’s Budget did not provide enough to chew on, the government has this year introduced the possibility of allowing existing annuitants to sell their annuity in exchange for a lump sum.

But can a traded (or secondary) annuity market really work? The jury is out.

Common consensus is that it would only work on a ‘whole of market’ basis, to ensure that savers have access to competitive rates. Even if the market does develop it’s unclear how many people will actually benefit from tradeable annuities.

Ms Vahey points out that any annuity will be valued on the basis of the customer’s current health and the current annuity rates. But that customer may have taken an uncompetitive annuity originally and could have fallen into ill health since then.

“Add to that the buyer’s cut – because they need to cover their expenses and they are putting the money upfront - and it’s likely the customer won’t see anything like the return on their original purchase price,” she warns. “I can understand people’s frustration if they have made a poor annuity decision in the past, but selling it on may just be compounding that decision even further – and they may get a bad annuity deal not once, but twice.”

The devil, as ever, will be in the detail. But for a clue as to the future of annuities in a pensions regime geared towards greater freedom and choice it’s worth pondering developments down under.

Australians have pension assets that are the envy of virtually any other system, thanks largely to 1992 reforms based on compulsion and tax incentives. With savers allowed to take their whole pension pot as a lump sum from age 65 the annuity market is tiny.

But with research suggesting large numbers of people are depleting their pensions too soon there are calls for new annuity-type products to be developed.

It’s a cautionary tale for anyone expecting annuities to disappear from the UK market.

“It is interesting to note that in other markets where annuity purchase is low, such as Australia, a significant portion of the population run out of money during their lifetime,” says Mr Dick.

“Clearly, if anyone is going to enter a withdrawal-based flexible income strategy it is essential that they receive good advice at outset and at regular intervals throughout retirement. It is clear that many people seriously underestimate longevity which can lead to unsustainable levels of income withdrawal.”