The fortunes of the annuities market changed dramatically and unexpectedly on 19 March, as George Osborne delivered his Budget. “I watched the Budget in a room full of actuaries,” recalls Barnett Waddingham senior consultant Malcolm McLean. “You’ve never seen so many mouths drop open in your life. Everyone was gobsmacked.”
Osborne proposes that from April 2015 people aged 55 or over will be able to access their entire DC pension pot and spend or invest it as they see fit. The government had already ended (effective) compulsory annuitisation back in 2011, but this new change will have significant effects.
However, this will not mean the death of annuities, Pensions Minister Steve Webb told the House of Commons the day after the Budget, describing this as “an opportunity for the annuity market to provide new and innovative products”. Webb pledged to introduce “a guidance guarantee offering impartial advice on pension options... throughout the decumulation process”.
Of course, there are significant problems within the annuity market today, principally the fact that so few people shop around for the best annuity. A 2012 report from the NAPF and the Pensions Institute suggested that about 500,000 retirees were losing about £1 billion from their total future pension incomes this way, a figure it predicted would rise to £3 billion by 2022. But Legal & General pensions strategy director Adrian Boulding told the FT his company now expects the whole annuities market, currently worth around £12 billion, to shrink to between £4.4 billion and £6 billion.
Dr David Blake, at Cass Business School, City University and director of the Pensions Institute, is horrified. “The problem is, most people don’t really understand pensions,” he says. “They might intend to be responsible with that money, but they don’t know when they’re going to die.
“This is sheer vandalism of the pension system. We have the world’s biggest annuity market and it’s been destroyed. And the eyes are opening of all these snake-oil salesmen who can see all this money and will be trying to get it put into ‘interesting’ investments for vulnerable 80 year olds.”
It seems likely that many people with smaller pension pots, of £10,000 to £50,000, will chose to withdraw most or all of that money, hopefully in a tax efficient way over several years, rather than buy an annuity. “That solves another problem, because it was difficult to make it economically viable to advise those people,” says Peter Quinton, head of annuities at Retirement Assured, part of Buck Consultants.
But is Blake’s fear that this will lead to large numbers of people burning through money that should have provided their retirement income justified? McLean thinks not: “People who’ve saved for 40 years are not going to squander it then fall back on the state for support.”
Just Retirement customer insight director Steve Lowe thinks a bigger problem might be people doing things with their pension pot money that they think are sensible but are actually unwise, like using the money to pay off their mortgage, when working for another year or two instead might be a much better long-term option.
Impact on the market
What will happen to the annuities market? “You can expect a big drop in individual annuity sales, certainly in the short term and maybe in the longer term,” says McLean. “We’re already hearing about people trying to get out of annuities they’d signed up to.”
But the Association of British Insurers (ABI) director of policy and deputy director-general Huw Evans predicts that annuities will remain an important retirement product for many. “Moving to a more flexible retirement framework does not remove all the drivers for customers who want a secure, guaranteed lifetime income, but of course it may affect the timing and choice of product,” he says.
If the number of annuities sold does plunge there could be negative knock-on effects on rates, thus making the products even less attractive. On the other hand, it is reasonable to hope that this change will drive annuities providers to improve their products. “The problem for years has been a lack of competition,” says Hargreaves Lansdown head of pensions research Tom McPhail. “Now those companies are going to have to compete for their money. One consequence should be that the products will offer better value.”
We do already have an innovative annuities market, particularly in enhanced annuities. Lowe and McPhail both stress their belief that ever more retirees will now be individually underwritten when buying annuities, McPhail pointing out how quickly individuals can now go through the underwriting process online.
Annuities may also become more flexible. “I wonder whether in future you might have a product that is like an annuity but works on more of a risk-sharing basis, where you have a guaranteed minimum return, possibly something that allows you to switch to another provider after five years,” says McLean.
“There will be more hybrid solutions,” agrees McPhail. “You might have annuities where you take some of the pot and do something else with the rest. You might use some of the pot to buy £5,000 per year from an annuity, then use the rest for drawdown.”
Annuity providers may also develop new drawdown products. McLean believes many people will opt for drawdown if they compare and contrast the risks and costs involved with those encountered by someone using their pension pot for alternative purposes, like buying property to let. We may see more products like Just Retirement’s Fixed Term Annuity, a capped drawdown product that behaves a bit like an annuity, providing a guaranteed income for five to 15 years, without investment risk; or AllianceBernstein’s Retirement Bridge, which allows people to draw income from their savings before annuitising in their 70s.
But one advantage of the annuity model is its simplicity. Drawdown is not simple. And as Schroders head of the business development group Neil Walton puts it: “As you get older there comes a point where mustering the energy it takes to manage your finances becomes really hard work.” In many cases the capacity to take proactive investment decisions will be impaired by the symptoms of dementia.
However, “it’s easy to make drawdown seem frightening,” says Towers Watson senior consultant Will Aitken. “I think it is going to get simpler, but the investment side is never going to be really simple.”
It all comes down to the quality of the advice available – and that, at present, remains an unknown. “The idea that good advice can be provided across the population at very low cost is not plausible,” says Walton. Indeed, PwC suggests that the cost of delivering free face to face guidance for DC scheme members at retirement could reach £120 million per year. It will also be a challenge to get the new system in place before April 2015.
“The rules and regulations around who provides that service will be absolutely critical,” says Lowe. “We believe that the guidance or advice offering must be provided by an independent entity, to ensure its impartiality. Maybe it will be networks of IFAs, who would need to pass a stringent regulatory test.”
Another key question is what effects the extended investment allowances for ISAs might have on people deciding how to save for retirement. “It is possible that the flexibility of the ISA will be seen as more advantageous than the pensions system, but I would hope that the employer’s contribution would weigh against that,” says Walton. “But at a macro level, the savings of the nation that used to go into bonds will find their way into a wider range of assets – which is probably no bad thing.”
“We don’t think annuities are going to die,” says Broadstone Pensions and Investments pension director Simon Nicol. “Sales will reduce, but there will still be a place for annuities, particularly if you’ve gone through drawdown for 10 years and want the certainty of an income for life. For many people buying an annuity is still going to be the right thing to do.”
David Adams is a freelance journalist