Some twenty years ago the famous marketing guru Peter Drucker said that life insurance companies had to reinvent themselves. Why? Because people were no longer concerned about dying too soon; their concern was about living too long.
It seems strange therefore that the government has ‘abolished’ annuities. In the short term everyone is delighted, but I foresee grief when the money runs out before one’s life does. I think the government has tackled the wrong problem. The problem is not with the principle of guaranteed annuities; the problem is that with quantitative easing, gilt yields are ridiculously low. No one in their right mind would commit themselves irrevocably to gilts in today’s conditions. They should be investing in equities.
Increasingly, old people are investing in high-income equities as bond yields are so poor. What an insurance company should do is to take that asset and add longevity protection. How could they do that? By issuing equity-linked variable annuities.
This is not a novel idea. It has been done before. As long ago as 1969 International Life Insurance Company (UK) marketed just such a product. It did not sell, but there was a good reason for that. Right product, wrong time.
That may sound like an excuse, but it is not. At that time, gilt yields were around 8.5 per cent, whereas the dividend yield on equities was around 4 per cent. Thus anyone taking out a variable annuity would have to accept a substantial reduction in income compared with a guaranteed annuity; some 30 to 35 per cent less. That was too big a drop. It was an idea ahead of its time.
I believe that its time has come. Today’s circumstances are not just different, they are ideal. Long-term gilt yield is around 2.75 per cent, and the running yield on equities is around 3.75 per cent. Instead of a guaranteed annuity of, say, £55 per £1,000 of purchase money, they could have a variable annuity of £60. It will have no downside protection, but surely that is a risk worth taking? The income may be expected to grow at, say, 5 per cent a year, so that in 20 years’ time it may amount to £160. The income admittedly would fluctuate and could be much lower – perhaps only £100 – but equally it could be as high as £200; either way there is daylight between that and the guaranteed annuity of £55.
Even if the rate of increase is less than 5 per cent, the results are extremely worthwhile, as the following table demonstrates:
| Income in year: | |||||||
| Annual increase in income | 1 | 5 | 10 | 15 | 20 | 25 | 30 |
| 4% | £60 | £73 | £89 | £108 | £131 | £160 | £195 |
| 3% | £60 | £70 | £81 | £93 | £108 | £126 | £146 |
| 2% | £60 | £66 | £73 | £81 | £89 | £98 | £109 |
| Guaranteed annuity | £55 | £55 | £55 | £55 | £55 | £55 | £55 |
A man retiring at 65 has a one in four, maybe even one in three, chance of living to age 95, so income in extreme old age is important. Of course, that is a reason for not purchasing a guaranteed annuity. However, if instead of buying an annuity, you took a drawdown from an equity portfolio, there is every chance that you will run out of funds by 95. That is why an equity-linked variable annuity is important.
Should the idea be accepted and the product takes off, clients who purchase it would be substantially better off. However, twenty years later when they are enjoying an income of, say, £131 (see table), they would forget that the alternative they did not take would have given them a mere £55. So if there were a 30 per cent crash in the stock market and the income dropped to £92 they, or the press, would undoubtedly look for a scapegoat, usually the adviser. That is the world we live in.
However, once the idea is accepted, it may be possible, for a slight reduction in income, to moderate the fluctuation in income by introducing a cap and a collar. The result is a much better long-term income. And you have longevity protection.
Icki Iqbal is a former director of Deloitte
