Sandra Haurant explains why enhanced annuities are no longer just for retiring DC scheme members
The idea of receiving an increased retirement income based on reduced life expectancy is something individual consumers have been embracing. According to figures published by Towers Watson in February, sales of enhanced annuities reached £4.38 billion in 2012, a rise of an impressive 49 per cent compared with 2011 and more than a ten-fold increase on sales in 2001. Sales from October to December hit a quarterly record of £1.32 billion.
Towers Watson investment consultant Mark Williams said at the time: “Over 85,000 consumers benefited from higher pension incomes because their medical condition or lifestyle has been assessed and a lower than average expectation of life anticipated.”
Perhaps this increase is down to a greater awareness and improved education – larger pensions for people whose life expectancy may be shorter than average, perhaps due to serious medical conditions, smoking, obesity or occupation, are something that consumers can understand. And that being the case, undergoing tests or filling out forms to underscore health issues that may increase your retirement income clearly makes sense – even if it does mean facing some pretty difficult questions. “For an individual, there is of course a vested interest,” says Barnett Waddingham associate Gavin Markham. “There is a direct return involved.”
The case for DB
But for defined benefit (DB) schemes, of course, the picture is quite different. Here, the benefit is fixed and uncovering medical issues that could reduce life expectancy will not result in a larger income. It might, however, have a positive effect on the pension scheme as a whole.
The Pensions Institute published a report in February that claimed thousands of smaller DB schemes could find significant savings by using information relating to the health of retired members with shorter life expectancy to bring about lower premiums to insure benefits.
Partnership director of corporate partnerships Will Hale explains: “The situation for trustees and sponsors has been the same for some time. They are faced with very expensive DB liabilities and are looking for a way to de-risk. As a result, the market has built up to offer bulk annuities that help with de-risking.”
Obtaining information
Of course, in order to underwrite on a medical basis, you need to gather a lot of potentially sensitive information from clients relating to their health and lifestyle. “Overall the trustee community are very supportive of this approach,” says Hale. “Although there is some nervousness because it requires communication and contact with the pensioner community.”
After all, the process involves estimating whether or not an individual has a greater chance of living a shorter than average lifespan – and here there is not the promise of an increased income, only that the scheme could be in better shape thanks to cost savings, so it could potentially be harder to encourage members to offer the relevant information. “It can be quite invasive,” says Hale. “Which is why, at Partnership, we devised a method that involves one simple questionnaire.” The questions are straightforward and easy to answer, concerning health issues that people will be aware of and able to confidently answer straight off. Examples include: ‘Have you smoked more than 10 cigarettes a day for more than 10 years?’ and ‘do you have diet-controlled diabetes?’ There is no need to rummage through old prescriptions,” says Hale.
It is simple to reply to, and generally speaking members are happy to offer their information. Armed with the answers, it is possible for a scheme to demonstrate that, overall, members’ longevity is expected to be shorter than average. As a result, enhanced annuities can be used to reduce the cost of buyout or buy-in, and significantly help with de-risking. And it can be cheap to set up, too, says Premier Benefit Solutions director Ian Gutteridge. “Plenty of advisory firms can do this in a very cost effective way.”
The right concentration
The approach will not work for all schemes, particularly at the larger end of the scale, says Markham. However, he says: “For the right schemes this may make sense. This will typically work best for those with lower than average life expectancy. If your scheme members have a higher than average longevity it won’t work. And for larger schemes, as population size grows, the longevity trend moves more towards the average.”
And, explains Markham, it can help to concentrate on those members that will have the greatest influence on the liabilities of a fund. “Really you want responses from the larger liabilities, from management and those on higher salaries. That is where the real difference will be made.”
Generally speaking, smaller schemes will benefit most from the enhanced annuity approach, and particularly those where there is reason to believe life expectancy may be lower than average. These schemes might be in industries that could be linked with shortened life expectancy, such as manufacturing, construction, and other industries with great amounts of manual work, for example.
It is important to have a good idea of whether or not the average longevity of members really is shorter before entering into the enhanced process, explains Markham. “If trustees go down medically underwritten route and they don’t transact, they will run into problems.” If trustees begin to go down the route of the medical underwriting, they cannot later go back on the decision in favour of a conventional bulk annuity. If members turn out to have a higher than average longevity, for example, it will be more expensive to insure, and data relating to the health and lifestyle of their members must be declared once they have it. As such, it is wise to research thoroughly in advance, and to work out the likely outcome before entering into an enhanced annuity process.
The growth of bulk enhanced annuities
With the individual market for enhanced annuities growing fast and furiously, it stands to reason that the market for bulk enhanced annuities may follow suit. Indeed, says Hale: “It’s an area where the retail market has been leading the institutional market.” Interest appears to be growing with some of the names such as Legal & General and Aviva getting involved, and specialists in individual enhanced annuities such as Partnership and Just Retirement making moves into the bulk enhanced annuity arena.
Earlier this year Aon Hewitt urged trustees to look into these opportunities sooner rather than later, striking while the iron is hot and the market is burgeoning. In May this year, Aon Hewitt risk settlement group principal consultant Dominic Grimley said: “It is unusual for small schemes to have the best opportunities, but as the market begins to gain momentum, providers are keen to gain a foothold and prove the concept – and that can lead to the kind of attractive pricing that is currently available.
“While medically underwritten annuities will not be feasible for securing large pensioner populations, there is currently a window of opportunity to secure annuities on appealing terms for deals for up to 300 pensioners. This reflects the providers’ desire to develop the market - and potentially has no impact on cash funding requirements,” said Grimley.
Nonetheless, this is still a new and developing market, and while many argue that all annuities should be underwritten to ensure the best deal, the industry is not quite there yet. Nonetheless, there is certainly scope for greater take-up of this approach, says Markham: “There are more recognised participants coming in, and a greater level of competition. It’s one of those innovations in early days, and there is capacity for more – but it is hard to say at what pace it will grow.”
Written by Sandra Haurant, a freelance journalist
WATCH: Partnership director of corporate partnerships Will Hale spoke to Pensions Age editor-in-chief Francesca Fabrizi about bulk enhanced annuities earlier this year. Access the video here.
