We need to do something about annuities

Compulsory annuitisation is a political  issue in the UK and in the USA.

However the tectonic plates are grinding in opposite directions.

The Fed is making noises to introduce compulsory annuitisation while the Conservative and Liberal Election manifestos promise an end to the compulsory annuitisation of pensions at 75. These have now been repeated in the ConLib agreement.

An extreme view from the States is that the Fed is trying to nationalise retirement savings by seizing inheritable wealth in the 401k system to fund the US budget deficit!

Philosophically, the argument is between those advocating freedom of choice and those advocating “Reasonable Force” to ensure reckless investment strategies do not dump pensioners back onto state hand-outs. 

The argument for annuitisation is based on LDI. There is no logical reason for deriving a stable lifetime retirement income from equities. Nor is there logic in regarding a pension as a means of passing wealth between the generations. As Paul Sweeting puts it,  “Removing annuitisation by 75 is fine but guaranteed income in extreme old age is good”. He quotes Moshe Milavi’s work on Advanced Lifetime Delayed Annuities.
What surprises me is the number of pensions experts who support LDI as the obvious end-game for Defined Benefit Schemes but oppose annuitisation within DC.

This confusion may be as a result of distrust of compulsory annuities in the UK. Noel Fitzgerald has recently suggested that the “Moneysworth” value of annuities has significantly fallen over the past ten years.

While the fundamental arguments for annuity purchase are strong, there may be a timing issue that has distorted annuity pricing as insurers ponder the implications of solvency II and the current uncertain picture for bonds.

There has been a decoupling between gilt yields and annuities which has driven annuities to historically low levels

Annuity rates graph

Blue- annuity rates, gold- corporate bond yield, red- gilt yield

Thanks to Tom Mcphail of Hargreaves Lansdowne for the graph and permission to publish

Put one way, if you can get as many pension pounds from investing directly in gilts as buying an annuity-why sacrifice your capital?

Put another, there is something fundamentally wrong with the annuity market that needs to be fixed.

To date, the majority of thinking on “LDI and DC” has concentrated on improving the accumulation phase of DC pensions. Since many people will be drawing their DC pensions for as long as they accumulate, perhaps the emphasis should now shift to creating better value from the annuities that DC pensions should be buying..

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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2 Responses to We need to do something about annuities

  1. Annuities says:

    Great Information on Annuities.

  2. Pingback: Let’s fix broken pensions, not start again. | The Vision of the Pension Plowman

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