I like the idea of an annuity for the rest of my life. A monthly dollop of cash into my bank account till my dying day, without me having to get out of bed, seems a very good idea indeed. If I had £100,000 and was 2 years older than I am today, I could get an income for life of £5,800 a year which seems a decent deal even if inflation will eat into my payments over time.
But I am 48 and for the first time since I was a teenager, I find myself wanting to be a little older. Why do I worry?
I’m worried for two reasons.
Firstly, changes in the rules means that I won’t be able to cash in my pension fund in 2011 as i had thought- I’ll have to wait until 2014 which is the new minimum retirement age for youngsters like me.
Secondly I have read the proposals by the European Union on the Solvency standards that are going to brought in in 2012 and I’ve asked around my actuarial friends about what they mean. The consensus is that these new standards, known as Solvency II, will effectively knock 15-20% off the pension I can expect.
Imagine it- the prospect of a 15-20% pay cut for the rest of my life and all because the Government changed the rules.
So how has this happened? What is the point of this Solvency II thing?
The idea behind Solvency II is to give consumers like me greater financial security when we buy things like annuities. This is odd. I have never had the slightest doubt when I buy a life assurance policy in the UK that the policy won’t pay out in full. I know that the life insurance companies in the UK are well-regulated, properly disclose their finances and have a history even when they get into trouble (as the Equitable Life did) they get out of trouble under their own steam. In extremity I can rely on the Financial Services Compensation Scheme for at least 90% of my investment.
I really don’t want to exchange 15-20% of the income I’m expecting for the rest of my life in return for more security- I’ve got enough already thanks.
The Life insurers seem to agree with my point of view and they are lobbying hard through the Association of British Insurers (ABI) to get the EU proposals dropped. The masterminds of the EU proposal are a group called CEIOPS – the committee of European Insurance and Occupational Pension Supervisors. They advise the EU commissionaires and the hope is that the ABI can appeal directly to the EU and by-pass CEIOPS.
I’m not sure whether the ABI will win the day and I want a Plan B. Plan B for those with £100,000 or more to buy their annuity is currently “income drawdown” a process which allows you to draw an income from your investments till you are 75 without having to buy an annuity. Income drawdown may buy me enough time to wait for someone to sort his out but it’s not much use for those less lucky than me for whom it won’t be an option.
As I’ve argued in previous articles, we need a Plan B for those who don’t want or can’t use income drawdown. If the EU think that the security offered by a UK Life Company is insufficient then perhaps we should be asking to exchange our pension wealth with an organisation where the security is good enough. I’m thinking of the UK Treasury which is very used to paying income from lump sum investments through the issue of Government Bonds aka Gilt-Edged Securities.
What I’d like to see the Treasury thinking about, is a type of Gilt Edged Security that mirrors the properties of an annuity payment. I call it a Pension Pound. The Pension Pound would pay a pound of income every year till its owner died and I’ve argues that it should be priced to compete with a competitive open-market annuity rate. If a competitive open market annuity rate is artificially depressed by 15-20% in 2012, I would like to see the risk-free pension pound be priced 15-20% better than the open market annuity rate.
Plan B is pretty radical. It would mean that most people would buy their annuity from the Government but there are advantages to this. We can be pretty sure that the Government will need to issue plenty of bonds for the foreseeable future and they have a very efficient and universal system of paying income to pensioners. We might no like it that we the tax-payers, are being asked to take so much longevity risk (the risk of people living longer than expected) but this risk can be laid off to the private sector (there is a thriving market in longevity swaps).
I’d like the Treasury to be thinking about this pretty urgently. 2012 is only 2 years away now and it’s not only the year when EU Solvency II comes into force, it’s the year that the largest pension initiative undertaken in the UK in modern times is due to come in force- the introduction of Personal Accounts. If Personal Accounts, which will require annuities to be purchased, are to win our heart and minds, they had better offer the annuity rates we have become used to.
Now if you are beginning to feel a little worried about all this, spare a thought for the trustees of the occupational pension schemes that have been and are planning their investment strategies around being able to buy out your pensions through wholesale or “bulk” annuities. If the cost of doing that also rises by 15-20% then they are going to need a Plan B too. Plan B for occupational defined benefit schemes is the subject for another article!
“when they get into trouble (as the Equitable Life did) they get out of trouble under their own steam. In extremity I can rely on the Financial Services Compensation Scheme for at least 90% of my investment.”
Are you joking? Equitable Life reduced my annuity by 60% and nearly 10 years later I am still awaiting compensation.
This is a very thoughtful and interesting contribution, Henry. There are two things I would like to add to this:
1. One possible option is something like the CREF annuity in the US. This is a pooling vehicle for mortality risk rather than a guaranteed annuity. CREF annuities — particularly if there are underlying investments in aggregate mortality securities or swaps – may be an attractive non-insured option for the future.
2. The Singapore government recently launched an annuity product as part of its CPF fund. This product has four options, with varying degrees of annuity amount and cash. Governments have issued annuities before (the problem is crowding out private markets).