A few months ago the prospect of a realistic second-hand market in annuities looked about as likely as Britain ever winning tennis’ Davis Cup again – but just sometimes the unexpected happens.
The government first announced plans for a tradeable market in annuities last year (2015) as part of the ‘freedom and choice’ reforms. The premise was sound – that pensioners who had missed out on the reforms and had already bought an annuity would have a second chance to access their pension savings cash upfront.
Market participants were the chief sceptics, doubting that such a thing were possible in practice, questioning whether the necessary infrastructure existed or whether insurance companies would be prepared to facilitate such a transformational manoeuvre. But in December we discovered that the government had every intention of making good on its promises, announcing that trading in an annuity would require advice and that private sector bureaus would be allowed to act as brokers, with insurers likely to be allowed to buy back their own annuities.
Plenty of details remain to be worked out, but assuming they can be worked through, under what circumstances would selling back an annuity be the right decision for the consumer, and what could lead to a positive recommendation to do so?
Consider the example of a 65-year-old man who had bought a two-thirds joint life annuity in February 2015, just before the new rules kicked in. It just so happens that this was one of the worst months ever for buying an annuity, and, according to figures from William Burrows Annuities & Retirement, he would have received an income of about 4.6 per cent, or £4,600 a year for £100,000. Four years earlier his £100,000 would have bought an annual income of roughly £5,800 – and last month it would have bought £4,900. So how much is his annuity worth today, and how much would it be worth if prevailing rates were back at February 2011 levels?
For this slightly back-of-a-cigarette packet estimate, it makes sense to price annuities as if they were perpetuities, which is a type of bond traded in the market with no redemption payment and no fixed end date to interest payments. Of course, in practice annuity actuaries would take into account the life expectancy of the annuitant as the most likely end date of the payments.
An annuity that was yielding 4.6 per cent when it was bought would be worth £93,700 with prevailing annuity yields at 4.9 per cent and £79,200 with yields of 5.8 per cent. If annuity rates improve – because the underlying gilt yields which drive prices have improved – then the value of your annuity will fall. Just because current annuity rates offer better value will not be a good reason to trade in your annuity – any more than selling a bond priced when rates were lower in order to buy a bond today when rates are higher would ever make sense.
Trading your annuity the other way around might make sense though. If you had bought an annuity for £100,000 in February 2011, it would have been worth about £119,000 in December 2015, using the same perpetual formula; in short you would have made a 19 per cent profit even after taking the income in the meantime.