I have been worrying about a presentation I have to deliver to an investment group on the value of annuities.
I have long felt that annuities are a rubbish investment and UK annuities a particularly rubbish investment.
My confidence fell still lower when my chum Alan Higham started tweeting me some heavy doodoo.
Alan wasn’t just talking big- he’d done the maths.
And he carried on….
This last tweet turned a light on in my head.
If the underlying securities which back your annuity are the same in the UK and the US but the income from the US annuity is 20% higher, either UK annuities are considerably less efficient or there is a greater degree of security from our income streams.
15 years ago, I spent some time with Mike Orszag who’s now Head of Research at Towers Watson but was then researching annuity costs at Birkbeck. He concluded that the UK annuity market was efficient, relative to other annuity markets. You can read his research (which has been updated but makes the same conclusions) here.
Last year I went to Kingswood to visit Legal & General who showed me the accounts behind their individual annuity book. L&G are not making huge margins and their business is efficient.
So how can we account for the differential between UK and US annuity rates?
The answer (for me) rests in perception. Annuities are not investments, they are insurances. The pension annuities we purchase are specifically an insurance against us living too long.
Insurance is unfashionable and investment is sexy. Insurance is boring but it brings peace of mind. Investment is flashy and doesn’t! The two concepts are faces of the same coin and many investments are sold as an insurance (against for instance inflation). Sadly annuities have been sold as investments (and they really don’t stack up well).
I could go off on a long tirade against the damage done to the UK annuity market by EU Solvency II and other regulations including the infamous gender equality rules – but I won’t. These regulations are what make for the 20% differential between US and UK annuity rates but they are the symptom not the cause.
America has a history of institutional failures within financial services, Fanny Mae and Freddie Mac, Lehmans and Bear Stearns and the Savings and Loans crisis all resulted from “under-prudential” financial legislation.
We cannot have our cake and eat it. If the price to pay for guaranteed annuities is the reduction in yield occasioned by reserving under solvency II, it is a price worth paying- if what you are after is an insurance.
My mistake- and I count it as such- is in confusing an annuity with an investment.
The 2014 budget reforms have cleared my foggy brain. If I want to invest, I use flexible drawdown and flumps, if I want to insure I use annuities and if I want something in the middle , I use CDC.
And I think I know what I’ll be saying when I talk at the Investments Network meeting on 16/17th October