A definitive solution to the annuity crisis.

Crisis – what crisis?

  • The DWP estimate that in 2012, 800,000 people will reach the age of 65.
  • In 2009 460,000 people bought guaranteed individual annuities from DC pensions
  • 86% of these annuities wer purchased on a level basis and had no inflation protection
  • Forget RPI/CPI – the pensions we purchase these days are NOPI

We’re not being foolish purchasing NOPI pensions, we just can’t afford better. A combination of low gilt yields, the reserving requirements of EU Solvency II, the high operational costs of individual annuities and the opportunity cost of not being exposed to real asset growth mean that the average punter goes for jam today because he can’t afford jam tomorrow.

A stark illustration of the costs of individual annuities is contained in GADs supporting document to the Treasury‘s LTA consultation document in the autumn, GAD suggests that the annuity cost for a CPI linked individual annuity purchased at 60 on a joint life basis would be 28:1 (were they available). However, the cost for an occupational pension providing the same thing is reckoned to be 23.6:1.

Put in layman’s language, individual annuities are nearly 20% less efficient than pensions paid from occupational pension schemes.

The only way that we can make a tangible difference to the pension in payment of those with DC pots is to give them access to scheme pensions.

In years gone by, occupational schemes did buy back money purchase pots – especially AVCs. They are not sufficiently solvent to do so any more, in fact they’re busy trying to switch DB liabilities to DC liabilities using ETVs.

In years gone by, insurance companies allowed annuitants to participate in the real asset growth of their funds by offering with-profits annuities. It is unthinkable that insurers would re-open such funds for this purpose given the costs of the underlying guarantees.

Sadly, it is unrealistic and unreasonable to expect the private sector to provide scheme pensions. However there are two quasi-public pension that are fit for purpose, The first is NEST and in the longer term NEST will have the assets and numbers of pensioners to operate collective dc decumulation. BUT NOT YET.

In the short-term we have the Pension Protection Fund, as Defined Benefit Pension that provides guaranteed pensions from its funds to distressed pensions and pensioners.

It is realistic and reasonable for the PPF to open its doors to DC annuitants. It is an organisation set up in the public interest, has the assets and the infrastructure to manage both the assets and the liabilities of scheme pensions. It is well run.

While the PPF is supported by a levy on occupational schemes, it’s sister organisation the Financial Assistance Scheme is supported by the tax -payer. I’d like to see a similar structure being established to provide scheme pensions, leveraging the PPF’s investment clout but underwritten by UK plc.

So, by taking on the role of the nation’s default annuity provider, the PPF will  be  transferring long-tail longevity risk back from the private sector to the tax-payer . But is this anything new? Let’s face it, the 86% of annuitants buying level pensions are going to find themselves so impoverished by inflation that they look a much greater liability.

Crisis – this is the crisis; the decision to purchase level individual annuities is irreversible. Currently those retiring with DC pots have two choices, income drawdown and guaranteed annuities. Income drawdown will never be a mass market solution, individual annuities are an inadequate solution.

It is time that we started using our existing infrastructure, the PPF, the DWP pension payment system and the ultimate covenant  of the UK tax-payer to sort out this mess. 

About henry tapper

Founder of the Pension PlayPen, Director of First Actuarial, partner of Stella, father of Olly . I am the Pension Plowman
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