A new dawn for the annuity market

A new dawn for the annuity market

Falls from grace are a common occurrence in financial services, but the rate at which annuity sales dropped in the aftermath of the 2014 pension reforms is perhaps unrivalled. 

George Osborne’s pension freedoms announcement took the industry by surprise and saw sales plummet. With the “freedom and choice” agenda riding roughshod over the promise of a guaranteed, if limited, income, many predicted that annuities would become extinct in the coming years.

The bad news for the market did not end there. As providers exited en masse, annuity rates experienced a further slump as loose monetary policy, record low bond yields and a lack of competition had an impact. 

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The number of firms offering guaranteed income products has also shrunk. There are now five main companies – Aviva, Canada Life, Just Group, Legal & General and Scottish Widows – actively scrapping it out over what the regulator estimates to be 60,000 to 80,000 people buying annuities each year. 

But while the market is more concentrated, individual company results suggest claims of extinction are still far-fetched. Last year, Legal & General increased its annuity sales volumes by 78 per cent, with annuity premiums jumping £293m to £671m.

“We believe there’s room for the market to grow,” says Emma Byron, managing director of individual annuities at the firm.

A recent data bulletin published by the FCA shows annuity sales are still falling. From April to September 2017 volumes were down 13 per cent from the same period in the previous year. In contrast, new drawdown plans and uncrystallised fund pension lump sums were up 17 and 34 per cent respectively.

But a variety of factors have been tipped to drive growth in the annuity market, lending it greater longevity. 

Rate expectations

Two political and economic uncertainties may prove pivotal to sustaining the growth enjoyed by the likes of L&G.

The Bank of England’s (BoE) decision to raise interest rates in August, albeit by only 0.25 per cent, should boost the annuity levels providers are able to offer. In itself the increase will make little difference to annuity rates, but further base rate hikes would start to change the equation.

The severity of the tumbling annuity rates has been a telling factor in the products’ slump. Chart 1 highlights the extent of their downward trajectory, with rates almost halving between 2008 and 2016. The BoE’s decision to loosen monetary policy in response to the financial crisis, resulting in lower gilt yields, was a key component of this, as well increasing life expectancy across the UK.

However, the chart also indicates a reversal of this trend. While much lower than they were 10 years ago, rates have risen 20 per cent over the past two years due to a recent rise in 15-year gilt yields. Life expectancy trends have also started to reverse, though these are unlikely to have been factored in at this stage.

The second fundamental factor which could drive growth centres on investment markets that are now looking more fully valued. An increase in volatility would boost the attraction of a guaranteed income. The potential for market uncertainty is exacerbated by the current state of Brexit negotiations, where a lack of progress has meant even the staunchest Brexiteers are showing signs of jitters. Kim Lerche-Thomsen, founder and chief executive at Primetime Retirement, says: “Sometimes people don’t understand the investment risks they’re taking and their capacity to take the loss on it. Can you really put your hand on your heart and say people should be going fully invested into the equity market, given that no one has the slightest idea what’s happening on 29 March next year?”