The Great Debate UK
Why the bulk-annuity market won’t revive
- Richard Jones is principal at Punter Southall Transaction Services. The opinions expressed are his own. -
A bulk annuity buy-out is an insurance contract which allows a defined benefit pension scheme sponsor and its trustees to absolve themselves of their responsibilities in regard of the accrued liabilities to members.
During 2005 and 2006, the buy-out market saw new mono-line insurance providers challenge the more established and diversified market players such as the Prudential and Legal and General. Despite the attractiveness of certain aspects of this insurance product, the premium required makes buy-out too expensive for many pension schemes.
Successive government statutes establishing stricter regulation, more transparent accounting disclosures and substantial movements in asset markets have made defined benefit pension schemes an increasingly unwieldy and frightening animal for companies to manage on their balance sheet. Buy-out provides a means to remove this risk: reducing the likely volatility of contributions and the exposure to longevity and investment risk.
Further benefits from a company’s perspective are that insurance companies may potentially have more efficient administration systems, and lower investment transaction costs due to large aggregate fund sizes. From the member’s perspective, the credit rating of an insurance company and the stringent oversight by the FSA may provide a better guarantee of benefit promises being met, than had they continued to be sponsored by their employer.
However, the transfer of pensions risk to an insurer is expensive. An insurance company faces the very same risks as a sponsoring employer of a pension scheme, but is encumbered by additional regulatory constraints associated with operating within an insurance regime and the obligation to make a profit. As a result the cost of purchasing annuities has historically been prohibitively expensive to most.
To generate interest in the market some of the new participants priced aggressively. Legal and General continued to compete, whereas some of the other players such as Lucida, Rothesay Life and Prudential appeared to cherry pick deals. This led to deal volumes rising to 2.9 billion pounds in 2007 and 8 billion pounds in 2008.
Second rate annuities can harm your income
-Bob Bullivant is chief executive officer at Annuity Direct. The opinions expressed are his own.-
There are two distinct phases in building a pension – first comes the process of building up a pension fund – the so called accumulation phase. The next part is actually turning the money saved into an income for life – or pension, the so called decumulation phase.
When it comes to buying an annuity there are many things to consider and getting any of them wrong can have serious implications for your pension income. The first thing that needs to happen is a proper forensic review of your existing pensions. This will include a report on any penalties that might be imposed by your pension company.
These might include early retirement penalties or in the case of with profit funds market value adjustments. The report will also consider if you are entitled to a guaranteed annuity rate as part of the policy as guaranteed rates are often much higher than rates generally available in the open market. Older policies may also have life assurance cover or premium waiver benefit attaching to them and if so then the impact on the cover of taking the pension must be understood.
Add all of this together and it becomes clear that there are many potential pitfalls. The interesting thing is that if you want to move pensions before retirement the FSA insists on all of these issues being investigated. The same requirement does not apply at retirement and so you are very much on your own unless you take professional advice.
Armed with all of this it is time to move to the next phase. This is where specialist skills are required to get the right income. There are a number of ways to generate income in retirement including income fund withdrawal which is a highly complex area and the rules about adviser selection outlined below apply equally to this area. For anyone wanting guaranteed income in retirement the selection of an annuity must be done with great care for the simple reason that it can only be done once. Obtaining the best rate and most appropriate options is therefore essential.
Once again there is a need for careful selection. Anyone with a health or lifestyle issue or who is a smoker should complete a medical questionnaire. There are over eight providers in the market for enhanced annuities and it is important that all of them see the questionnaire. There can be a significant difference between the top and bottom rate as a result of a provider’s view of medical conditions. Recently, one provider took such a stark view of a medical condition that it offered £7800 more per year than other providers.
Do you cater for someone with a small pension pot? I have £36,000 pension and want to maximise my income in retirement. My normal adviser wasn’t interested and I am worried that the offer I have from Axa isn’t the best.
The great annuity scandal
- Steve Hunt is Managing Director of independent annuities broker Rockingham Retirement. The opinions expressed are his own. -
The concept of an annuity has not changed in hundreds of years. In fact the first annuities sold were probably during Roman times where ‘annua’ were sold for a fixed period or for life; but today’s mortality is unprecedented in history. An annuity was never designed to be paid over 30 years, or even 20 years for that matter.
What concerns me a great deal is the number of people who are going to be living in poverty in 10 years’ time because they have bought an annuity. Or the number of widows forced into poverty because their husband had bought a single life annuity.
Let me explain why. Inflation may not be a problem now, and who knows when it will return, but return it will – that is a given. The vast majority of annuity sales are level (and a great many single life). At just 3% inflation an annuity paying £500 a month in 10 years will reduce to £370 a month and at 5% inflation to just over £300 a month. And God forbid we get back to good old 1975 when it hit 24%. Mind you, 24% inflation would significantly help the government’s debt problem! Now there’s a thought.
With so many final salary schemes now closing, the de-accumulation risk of retirement is also being passed to the members themselves who are ill equipped to make the right or indeed informed decisions; in fact, I am not sure many Trustees themselves are.
Decisions made on de-accumulation may be the most important decisions in someone’s entire life and once made are usually totally irrevocable if a whole of life annuity is purchased. It’s like taking out a 30 year mortgage which can not be changed in any way for the entire 30 year term!
The current retirement income process is scandalous and needs to be changed – and quickly; what is currently allowed to happen really beggars belief.
The FSA is pushing hard for advisers to adopt Treating Customers Fairly principles (many of us have been doing this for years) – this does not seem to apply to Life Assurance companies never has, probably never will.
cave canem
Beware of the dog
Pensioners must shop around to get best annuity
- Stephen Hunt is managing director of Rockingham Retirement. The opinions expressed are his own. -
If we keep going the way we are, disaster looms for millions of over-60’s in the United Kingdom.
The same way that a comment about having licked the boom-bust cycle was not only totally wrong but rather crass and irresponsible. The same is true about having beaten inflation.
Yes, we may be in a period of very low inflation — even deflation — but to think that inflation is not going to return at some point in the future I think is as flawed as believing we have beaten the boom-bust cycle. Coupled with a government policy of printing money, inflation is as inevitable as the Tories getting back into power. And if inflation comes back on the Tories’ new watch they can always blame Labour.
You have to remember that with so much debt in the UK and the U.S., global inflation won’t do respective governments any harm in the long run as far as their debt is concerned.
Let’s consider the facts. We have a hugely aging population. The baby boomers are all approaching retirement and the ratio of pensioners to workers will reduce significantly, putting a huge financial burden on those in employment. So don’t expect too much of an income in retirement from the state on the government’s pay as you go system.
So what about private incomes? Well, largely due to Mr Brown, many final salary schemes have now converted to money purchase. Now, in a final-salary scheme most had index-linked income, which is rapidly becoming a thing of the past. Many have now switched to what are called defined-contribution schemes or money purchase, which means the person retiring has to buy an annuity. “What’s the problem with that?” I hear you ask. Let me give you a list:
