I return like a dog to vomit to the age old question “so what are you going to do for income when you stop earning?”.
It seems that most people do not consider getting old an option. Which is perverse as we are blitzed with the “you and I are going to live forever” forebodings of the demographic timebombers.
People do not want to insure against living too long because they are certain they are going to die young. Some will be right, most will be wrong.
As a nation we are Townsendian rathan than Gallaherailian in our outlook. Which may be why we don’t comparethemarket.com annuity rates quite as avidly as we do our motor insurance premiums.
For another way of putting it, I refer you to
http://eprints.lse.ac.uk/24899/1/dp473(revised).pdf a research paper by Paula Lopes which asks the question “Are annuities value for money?” and “who can afford them?”.
Here’s what her research told her.
“The model draws some interesting predictions. First, the welfare calculations on
the access to annuities markets show that nominal annuities are welfare improving
even when sold at the empirically parameterized cost, which is above fair value. Real
annuities are welfare improving over nominal annuities when sold at a fair price,
but when we incorporate the empirically parameterized annuity premium the gains
become negative at all wealth levels”.
Put even more simply she thinks annuities are a good thing in principal but rubbish in practice. Which backs up what people have been saying to me for 25 years.
On the other hand we have some very strong research from the brothers Orzag which though a few years old now has not been superceded. It finds that relative to the costs of building up a pension, annuities are really rather good value. http://www.oecd.org/dataoecd/30/61/2402277.pdf
If anyone has been following recent developments on the proposed EU Solvency II directive, then they may have noticed that the levels of annuity income that can be bought from the Pension Pound is estimated to fall by as much as 10% from 2012. (see Investors Chronicle-30th June -article by Maike Currie).
If annuities are relatively good value and we can still buy at pre 2012 rates (with protection from our freinds in Canary Wharf) I would have thought that there would be a fair degree of interest on a “buy now while rates last” basis.
The old chestnut “my house is my pension” is wearing a bit thin-even if you could buy a sausage with a brick. The money markets are hardly a source of solace to the pensioner so you’d have thought that the purchased life annuity would be making an overdue comeback.
But I fear that a combination of the Townsendian aspiration and a reluctance to pay the annuity premium will continue to make annuities as popular as a f**t in a lift.
Interesting article Henry. And some good references.
Another report on the value of Annuities you didn’t cite but may be of interest is below. It is by Canon and Tonks. It was research commissioned by the DWP.
It broadly concludes that the market is valued fairly and annuities are a good buy. If that is the case the the strengthening of the regulations could only be met by a direct price increase. I’ve seen figures in well in excess of 10% quoted in the FT.
The question that comes to mind is where do annuitants feel the trade off should lay between price and security. Do annuity buyers always need to have protection such that the probability of insolvency within a year is *always* less than 0.5% or would a customer accept more risk than this, in exchange for a lower premium and the risk of forfeiting some of their future pension if people started living longer or the investments didn’t do as well as was expected? Effectively I am asking if anyone has quantified the risk appetite of annuitants and what this revealed regarding their risk reward trade off.
I don’t know if anyone has done any work on annuitant’s risk appetite though since the demise of with-profits annuities we haven’t had much chance to see!
I would like to see the Government issue longevity bonds which could be bought in stead of private annuities, leaving people to choose a slightly riskier private annuity without the over vigorous approach being forced through by Brussels-
Thanks for the comment which puts things very succinctly!
I would be concerned about the taxpayer underwriting more longevity risk than it already does at present (state and public sector pensions, inheritance tax receipts, long-term health and personal care costs, housing benefit, etc), especially in the face of a rising proportion of pensioners in society.
Reply to Andrew’s Comment
But would a longevity bond would necessarily increase the exposure of the UK Government to longevity risk? It seems that they are underwriting that risk anyway by being the pension provider of last resort and also being exposed to political pressure to maintain retirement incomes above a certain level. Government effectively have a large contingent longevity liability on their balance sheet which is not recognised. Issuing the bonds would at least focus policymakers of this obligation and make it a tangible liability.
It always seems to me that the main problem with longevity bonds is that there are a very limited number of private counterparties who would be prepared sit on the other side of the swap for a price that is affordable – at least in the volume that would need to be traded. It only seems that the government, with its ability to control universal retirement ages and taxation, is able to mitigate the costs of longevity.
Great posts, thanks.
my particular bug-bear is that there is no benchmark annuity rate or index.
It would be a great help if the Government (GAD) could publish a concensus annuity rate as a first step (using their own mortality assumptions) If the cost of buying a pounds worth of pensions at the official rate, we as annuity purchasers would be able to think about risk and reward,
If the Government could then establish an annuity service, linking into existing administration in Newcastle- even better,
I’ve suggested that a simplified annuity conversion rate- the Pensions Pound- would do a great deal for public awareness of the issue and is something that could and should be investigated by PADA- come on Andrew Young!
Pension Corporation call for longevity bonds