A number of factors are likely to determine future supply and demand of the decumulation market, as well as the industry’s capacity to continue to secure the retirement income of millions of pensioners.
These are retail trends, institutional and regulatory drivers, pricing issues, as well as supply and demand.
After a period in which annuities have been expensive due to low interest rates and challenging investment conditions, we are starting to see a resurgence in annuity values and consumer interest.
We put this down to higher interest rates, an enhanced focus on security in the wake of the Covid-19 pandemic, and heightened recognition of later-life care needs.
For example, our benchmark for the annual value of a single life, level and no guarantee period annuity for a 65-year-old man with a £100,000 fund stood at £6,283 in August 2022. This compared to £4,696 in August 2016 – an increase of about 15 per cent after allowing for inflation.
A lingering issue across all parts of the market is data quality.Will such increases be enough to stimulate annuity sales after a period in the doldrums?
Possibly, but there are also things that insurers, to some extent backed by governments that want to encourage higher levels of retirement saving, can do to make them more attractive.
One, already common in the UK, is offering the flexibility to allow drawdown in earlier retirement years but, importantly and less commonly, in combination with a facility to allow undrawn funds to continue to attract investment income.
Another change in practice that could be beneficial is including inflation protection in quotes as standard, with an explanation of how this benefits the annuitant to counter the historically low take-up.
Longevity pooling
Another potential market stimulant is longevity pooling, already well established in the US and Australia, which is now starting to gain traction in the UK as a potential retail decumulation option that appeals to some pensioners.
Of course, pooling of risk is hardly new to insurers. The difference here is that members pool their retirement funds and, for insurers, it can offer a way to spread longevity risk.
Although there is no guaranteed income, each year the pool members receive payments based on their probability of surviving.
Potential deterrents historically have been the regulatory regime, the high market entry barriers, the limited credit asset universe and time.Further benefits of pooling are that members enjoy investment returns and, in effect, they gain mortality credits from members who die.
After 10 to 15 years surviving members also receive a regular annuity based on accumulated funds to avoid the tontine effect, where a large windfall would go to the last survivor.
Institutional and regulatory drivers
Turning to pension risk transfer, or bulk annuities as they are known in the UK, 2022 was another strong year.
In late August, Legal & General’s pension risk transfer monitor reported an estimated £12bn worth of transactions took place in the first half of the year – an increase of around 50 per cent on the same period in 2021.
At the time, it forecast the overall volume in 2022 would be between £30-£35bn, which would be the second largest ever in a year in the UK.
However, there are more than £2tn of defined benefit pension liabilities that could be transferred to insurers over the next 20 years. Demand from pension funds exceeds supply. The question is whether insurers are able to step up to meet the demand.
With a core of active market participants in the UK, the availability of capital is not the issue.
Potential deterrents historically, however, have been the regulatory regime, the high market entry barriers, the limited credit asset universe and the time and bandwidth needed to get deals done.
Solvency II reforms
Elements of the proposed Solvency II reforms in Autumn 2021 would have added to this list of possible deterrents – a reason we have been working closely with the Association of British Insurers to identify and quantify likely impacts.
We welcomed the latest consultation response from HM Treasury, which “drops” the most onerous elements of the proposed reforms.
While the devil is in the detail, we think overall that proposed changes, such as the reduction in the risk margin, will increase capacity for insurers.
Widening the universe of assets with highly predictable cash flows may help match longer-duration liabilities.
If the industry wants to grow the market, maybe it is time for insurers to work together to streamline the deal execution process.On asset eligibility, private assets held by some pension schemes may be more palatable as an in-specie transfer on buy-out, which may be attractive to all parties.
So we remain positive that 2023 and beyond will continue to see high volumes of bulk annuity activity, including new entrants into the UK market.
Since the Covid-19 pandemic struck, we have observed diverging industry views on longevity.
The reason the different interpretations of the data between insurers, reinsurers and pension scheme actuaries matter is that they can lead to price dislocation and bulk annuity trading inefficiencies, including in some cases risk transfer deals not going through.
So, it would be in all market participants’ interests to discuss potential disparities in longevity assumptions early on in a process.
Supply and demand
The current decumulation market is experiencing a number of supply and demand issues. Prominent among them is that many insurers are refusing to provide quotes for smaller schemes or will only do so if they have exclusivity.
At the other end of the scale, while affordability for larger schemes has improved, deals are taking a long time to execute.
Most market players are confident that market demand for retail and institutional decumulation products can only increase.A lingering issue across all parts of the market is data quality; many pension schemes do not meet the standards insurers would like.
A typical consequence is that insurers will not accept all-risks policies, meaning that the pension scheme has to retain some of the basis risk and can be a barrier to deal execution.
Expanding capacity?
If the industry wants to grow the market beyond the current £30bn to, say, £50bn, maybe it is time for insurers to work together to streamline the deal execution process.
Today’s multiple round tender processes are extremely resource intensive and time consuming.
One potential approach could be a bureau that identifies schemes close to execution and enables insurers to work with pension schemes, for example, to help with investment strategy; use standardised cash flows to provide schemes with pricing on a consistent basis and aid de-risking timing; and streamline adviser time, aligning insurer, reinsurer and pension scheme actuary views on longevity and pricing.
Most market players are confident that market demand for retail and institutional decumulation products can only increase.
This may sound like good news for all, but of course no insurer can take their own future success for granted.
Waheeda Narker is retirement & decumulation segment lead, insurance consulting and technology at WTW
