BLOG: Will annuities sink or swim?
Suddenly, and without prior warning, a large part of the pension rule book was torn up and thrown away. (I am assuming here that nothing untoward happens between now and implementation next April – as 2015 is an election year, who knows?)
Over the years the requirement to buy an annuity has been watered down but has still been the preferred way of turning a pension fund into a lifetime income. In some ways the knowledge that annuities were always in demand perhaps made the market complacent – annuity providers did not realise that the world/market was changing around them. Retirement was becoming longer, making a fixed rate less attractive and, more recently, potential annuity purchasers were starting to question the value of the products they were buying.
So what is the future for annuities? Well, early days yet, but two schools of thought seem to be evolving.
Annuities are the only product to offer a guarantee of income and, in essence, provide insurance against living too long.
Consequently, there will still be demand for such products – particularly at later ages and perhaps as part of a mixed portfolio. As such, this is a real innovation opportunity for annuity providers to produce new products.
It has also been suggested that some of the ‘complacent’ annuity providers could decide to lower their profit margins and put more back in returns to the people who are buying the annuity.
In a nutshell, annuities, as one of a potential class of investment, will for the first time have to stand on their own two feet as an investment option.
The alternative view is that annuities will find it difficult to continue – providers will not want to divert capital into making old profits competitive, and even if they do, will find it difficult to maintain rates at their current level.
Annuities work on a pooled basis with a cross subsidy between those who die before their average life expectancy and those who live longer – those who live longer get a mortality gain from those who die early.
This works if a good cross section of people buy an annuity, but with other attractive options available, those who voluntarily buy an annuity could well be those who expect to live longer (‘adverse selection’, in insurance terms) and while there will still be some cross subsidy, it will be less than before and at older ages.
Whichever way we go, annuities have some features that could be key to a comfortable retirement for some. However, pension savers now have a choice and many will be attracted to the flexibility of the new rules. What this means for the business models of traditional annuity providers, only time will tell.
Mike Morrison is head of platform technical at AJ Bell