Choosing the right tine to unwind

The financial services industry has become a joke. Providers have to live with a complex set of regulations and yet there is no rule of law. We are entering a potentially dangerous phase as the government is bribing its natural voters away from Ukip by offering giveaways that cost little – indeed, they may generate additional tax – in the short term, but have long-term consequences.

The latest fad is unwinding annuities. I am not against it in principle, but you have to be satisfied that it is the right thing to do, and if you do decide to do it, the basis has to be right.

The issues to consider are:

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1. Insurers who have issued annuities would have purchased gilts to back them. When these are offloaded onto the market what impact would they have on quantitative easing?

2. Some insurers would have purchased corporate bonds or other assets in the hope of higher yield. These are less marketable and could cause liquidity problems and, in the extreme, damage the solvency of the company.

3. What about annuities – for that is what pensions are – payable from self-administered defined benefit schemes? Who would define the value of the annuities? Would you use a common basis for all pensioners in a scheme or take their health into account?

4. Most schemes are not fully funded. If all of them had to pay out the cash value of pensions that have already commenced, then the pensions of current employees and past employees who have not commenced their pension would be even more thinly funded. Trustees have a duty to all. How would they discharge their responsibilities?

5. If you allow unwinding annuities for private sector defined benefit schemes it would be difficult not to justify it for public sector schemes. The same issues arise for funded public sector schemes – but what about unfunded ones? The cash would have to be found out of the current year’s taxation or by further borrowing.

6. What would all this cash becoming available for investment in a short space of time do to the investment market? Give it an artificial puff?

7. If the government continues to keep interest rates low, people will find that they have to invest in riskier assets to replace the pension foregone. That could have unfortunate consequences.

8. Finally, it is unrealistic to allow unwinding for one class of pensions but not others, as the government might do in response to some of the concerns I have highlighted. Once the genie’s out of the bottle you can not put it back.

In setting the terms for an annuity the crucial assumptions are those of mortality and investment return. If the client wishes to cancel, say, six months after the annuity was purchased, the investment conditions could be different. If the underlying interest rate was 1 per cent a year higher then the investment the insurer is holding to underpin the annuity would be worth perhaps 10 per cent less. Also the insurer would be fearful that you were wishing to surrender due to poor health so he would make a heavier mortality assumption. It may be therefore that you would get back no more than 80 per cent of your monies. Now the so-called experts would say that the insurer has pocketed 20 per cent but that is not the case. It is value-neutral.