‘Survival pessimism’ means people are missing out on good annuity pricing

Many people in their 50s and 60s are underestimating their chances of survival and therefore “under-valuing” annuity prices which reflect actual longevity rates.

New research from the Institute of Fiscal Studies (IFS) published today, 24 January, found that the low value that people have placed on annuities coincided with the introduction of pension freedoms in 2015.

According to figures from the Financial Conduct Authority, 90 per cent of defined contribution pots accessed in 2013 were used to purchase an annuity, compared to just 12 per cent since April 2015.

The IFS said: “Since April 2015, these restrictions have been removed and all those aged 55 and over can access any amount of their DC pension pot and pay only their marginal income tax rate. Annuity purchases fell significantly in the period following these reforms.”

The study also found that men and women in their 50s and 60s underestimated their chances of survival to aged 75 by 20 per cent.

“For the overwhelming majority of individuals in their 50s and 60s, this survival ‘pessimism’ has the potential to explain why they would view an annuity that is priced in an ‘actuarially fair’ way (i.e. has a price which is equal to the value of the total income payments which people would on average receive from the annuity) as offering a less than fair level of income,” the study said.

Despite this, the IFS said that underestimating survival chances is just “one part of the picture”, with people also choosing not to buy an annuity as they anticipate having to make large one-off expenditures, pass on wealth to their children, believe they could reach a higher rate of return or feel “sufficiently provided for” by the state pension.

The IFS said that it employed an economic model of saving and consumption to predict how individuals choose to use their accumulated pensions.

According to the model, annuitisation rates are over 90 per cent when using ‘objective’ survival probabilities, compared to 50-60 per cent when using ‘subjective’ survival probabilities.

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