The Institute for Fiscal Studies has delivered a damning analysis of the government’s plans to open up a secondary market for existing annuity contracts, concluding that it will be limited or may fail to emerge at all.
Gemma Tetlow, senior research economist at the independent research institute, stated that at the very least, individuals will need to have access to good quality financial advice and guidance in order to navigate this new market – if, indeed, such a market does spring into existence.
The IFS report said that while the chancellor’s announcement “provides a welcome liberalisation of the market and is perhaps a natural next step” following the last year’s Budget at-retirement reforms, there are risks involved.
“However, there is a significant risk that the secondary market for annuities will be limited or fail to emerge at all, due to the potentially significant problems of ‘adverse selection’ in this market,” Ms Tetlow added.
If many of those looking to sell an annuity have good reason to believe they might die soon and if those buying the annuity cannot fully reflect this in the price – either because they do not have full information or because they are legally prevented from using some information - then prices on offer will assume that those looking to sell will be likely to die soon.
These prices will be unattractive to many potential sellers, an issue that arises in many insurance markets and is known as ‘adverse selection’.
Earlier today FTAdviser reported on the concerns of various industry technical specialists, who listed problems to do with valuing annuities, particularly a lack of sufficiently trained actuaries and the prohibitive costs associated with such work on small amounts of assets.
However, sister title Financial Adviser found that both LV and Legal and General are already looking into buying consumers’ annuities off them, although Royal London, Aviva and Aegon gave the idea a much cooler reception.
The comments come in the wake of plans announced at the Budget last month, during which chancellor George Osborne confirmed plans for the establishment of a secondary re-sale annuity market which is aimed to be in place from next year.
In the consultation paper published alongside the Budget, the government admitted that safeguards will be required to stop annuitants losing out once they are allowed to sell on their policy.
Ms Tetlow said: “Evidence suggests that at least a significant minority of annuity holders – in particular, older annuity holders – may struggle with the complex decisions required in valuing their annuity compared to an alternative lump sum.”
She noted women, on average, live longer than men, but it may well be illegal for purchasers to offer prices that vary by sex; meaning that the resulting market will be particularly unattractive to women. Individuals may also have better information about their survival chances than potential purchasers can hope to elicit.
Ms Tetlow said: “Valuing an annuity versus a lump sum is a complex calculation and requires people to grapple with uncertainty surrounding their own longevity, potential future investment returns and inflation,” said Ms Tetlow.
“Therefore, a further concern with this policy might be that some annuity holders are not well-placed to make such decisions and may – as a result of this policy change – make a choice that is to their detriment.”
She concluded that part of the animosity towards the old ‘compulsory annuitisation’ requirement was driven by a “not always well-evidenced” belief that annuities offered poor value for money.
“If the market for selling annuities was perceived not to work well, it is far from clear why a market for buying them back should work much better,” Ms Tetlow added.
peter.walker@ft.com
