Annuity re-sale plan could go ‘toxic’

I’m talking of course about pension minister Steve Webb’s laudable efforts to use what could potentially be his final months of office to realise a dream of extending pension freedoms to the millions of legacy annuitants locked into an income for life.

In an interview with the Telegraph last week, he raised the prospect of offering re-sales of annuities and said plans would be drawn up by the Department for Work and Pensions in the hope of securing cross-party consensus before the election.

This week, building on a swath of stories across the trade press in the intervening days, there was some informed speculation on how (and whether) this could work.

I have to say I’m not convinced.

As we’d stated in our coverage last Monday, instructive pieces in both the Telegraph on Saturday and the Sunday Times highlighted two options: a secondary market based on sales of the annuity income stream to ‘third parties’; or buybacks by the insurers themselves.

The first of these seems to be potentially “high risk” and “toxic”. Those remarks are in quotations because they are not mine, but the then Financial Services Authority’s comments several years ago in relation to similarly sold traded life policies, or ‘death bonds’.

As with the latter, secondary annuity re-sales would involve selling the income stream from one person’s mortality policy to another person or entity, who would receive this until the first person died.

The second person would effectively be offering a price in the hope that the first person died later than expected and thus they would win on the deal. As a hedge against the original annuitant having the temerity to die earlier, most would likely low-ball the assumed residual value.

This is precisely how life policy sales work in the US. After a series of failures affecting UK investors, the FSA spoke out against them strongly and banned them from being sold to retail investors.

I can’t imagine the regulator being too enamoured at a secondary market for retail investors gambling on death in this way, which as the Sunday Times states leaves the most likely buyers being institutional investors such as pension funds.

The income stream will be welcome, for sure. But I can’t see a pension fund buying thousands of individuals policies from sexa- or septuagenarians, so this would only work if annuities were bundled together and then ‘syndicated’. Who fills that role?

The alternative looks neither that much more attractive nor that likely to be realised.

Again, we raised the concept of insurer ‘fair value’ buyouts when Mr Webb first started on his crusade last October. It’s simple in theory: the original insurer buys back the contract at a mutually agreeable price.

In practice it’s far more complex. Several providers spoken to by FTAdviser back then dismissed the suggestion on the basis that it would undermine cross-subsidies, underlying assets are too illiquid, and it would likely cause rates to fall.

Most agree providers would wish to apply discounts of perhaps 20 per cent and would probably demand health checks. It is probable the net result of this would be a bias to those in better health and a critical undermining of the risk cross-subsidy.

All of this is not to say I’m not in favour of the spirit of the plans, just that perhaps the focus should be on those who have demonstrably got a raw deal in the past.

The recent Financial Conduct Authority thematic review into annuity sales found, for example, that the majority of annuitants who would qualify for an enhancement are not being told rival life companies “may offer enhanced annuities for medical conditions or lifestyle factors not covered by their existing provider”.

Customers of some firms could increase their annual income by as much as £278 by buying their enhanced annuity on the open market, meaning they’d been shortchanged by £2,428.

Elsewhere, the regulator said that while much of the printed documentation sent to would-be retirees was informative enough, the “majority” of telephone contact, the preferred method of communication for many savers, actively mislead customers.

Indeed, Aviva become the first insurer to announce a redress program for past annuitants in November.

The FCA has told insurers to do a “statistically significant” review of enhanced sales since its ‘open market option’ guidelines were published in May 2008 and report back.

I suspect and hope this will lead to a more formal sales review for a number of providers - and the thousands of customers who I for one believe were ripped off in the past.

ashley.wassall@ft.com