Look at any thriving market and you'll see a multiplicity of willing buyers and sellers. Competition maintains quality and keeps prices affordable. For a market to form in the first place though, there must exist both demand and a supply to meet the demand.
The government would like to see a secondary annuity market – their current consultation refers to “creating” one – but the conditions are hardly propitious. Probably there are potential sellers, but few buyers (only three so far have declared, all specialist annuity providers; and there are many reasons to doubt that sales will result).
This particular proposed market is complicated by the presence of other parties. Even if no broker or intermediary becomes involved, besides the seller (the annuitant) and the buyer (a corporate with deep pockets) the annuity provider plays a vital role. If the annuitant is to succeed in selling their future income stream, and drop out of the picture, the provider remains very much involved as they will be paying the annuity instalments to the buyer.
So they will be keen to know when they can stop payments, i.e. when the annuitant dies. While the annuitant is receiving the income, both parties have a vested interest in certifying the recipient is still alive. Post-sale, the provider loses contact as well as any contractual relationship with the annuitant, so how will they know when the annuitant dies? This goes un-mentioned in HMRC's consultation document.
Even without this new risk, it is hard to see why a provider would want to permit sales to a third party, because the commercial benefit is absent. Provider interest is likely to be largely confined to buying back their own annuities (a possibility which has had to be added to the government's original proposals, to breathe life into what was looking suspiciously like a corpse). For a nascent market to form it might still be necessary for the government to force providers to allow annuitants to sell their policies.
Of course providers won't want to do that unless there is a profit in it. This is the first of a string of so-called 'frictional costs' which will combine with the inevitable administration charges to significantly reduce the price which a buyer might be willing to offer. In a normal market the price is set by the seller, but this one resembles an auction, where the seller has no control unless they set a reserve.
There is also an asymmetry of information here between sellers and buyers, something inimical to a viable market. The only advantage a would-be seller might possess is a better knowledge of how long they might live. Well aware of this, which of course is crucial in estimating the current value of an annuity, any buyer will seek to obtain patient medical records or in extremis require a medical examination: another cost to be borne by the annuitant, directly or indirectly.
The FCA is aware of the risks to sellers, and is likely to insist on protection for vulnerable annuitants. The government will probably also require independent advice before an annuity valued at more than a threshold amount (which could be £30,000, in line with the threshold for transfers from defined benefit arrangements). Another slice off the price.
And as anyone who has ever tried to sell anything second-hand will testify, unless the item is rare it will fetch only a small fraction of what the owner paid for it, and nearly always less than what the owner feels it is currently worth.
So how low might annuitants be willing to go? A recent YouGov survey commissioned by the Institute and Faculty of Actuaries found that annuitants would be prepared to accept on average 94 per cent of the total amount of future annuity payments – 41 per cent of those asked said 'nothing less than 100 per cent’.
It is to be hoped, perhaps, that the gap between the buyer's price and the open market equivalent annuity cost (which the FCA proposes will have to be disclosed in the prospective buyer's quotation) will terminate interest from most would-be sellers.
However, assuming the annuitant is desperate enough to sell at whatever price is on offer, a further shock lies ahead - tax. The capital sum will be taxable as pension income at the individual's marginal rate. In fact almost certainly the prospect of bringing forward the tax that would have been taken annually for many years was the Treasury's primary driver in proposing this in the first place; even more than the political benefit in assuaging customer dissatisfaction with annuities and their perceived poor value.
The likely outcome of this exercise is market failure and a groundswell of resentment from disappointed annuitants who feel misled, abused and indeed looking for someone to blame. It's not hard to see who will cop the flak: the much-maligned financial services industry, vulturous rather than virtuous - a ready-made fall guy if ever there was one. The teflon-coated Chancellor will skate away with the (very) short-term tax gain.
Aries Insight director Ian Neale
This article represents the personal views of the author and should not be taken to be the views of either Aries Insight or Aries Members.