This blog offers insurers a simple way out of the problem they have with Guaranteed Annuity Rates- it means paying the reserved for value of the policy rather than the (lower) investment value of the contributions.

By way of explanation..

Guaranteed Annuity Rates (GARs) are defined benefit plans. They guarantee you an income based on the value of your fund at a defined point in your life. The Equitable life’s 200 years heritage was destroyed when Roy Ransom and his colleagues forgot this.

The Equitable had assumed that the guaranteed annuity rates embedded in their policies would never bite and for decades they didn’t. Then came the hungry years for income seekers, interest rates and inflation fell and guaranteed annuity rates suddenly became attractive. But the Equitable had insufficient reserves to meet the costs of paying these annuities and the rest is history.

The fate of the Equitable has always troubled insurers, especially mutual insurers who have limited access to the capital markets to meet unforeseen cash calls (again see the Equitable Life). So any statement from a mutual insurer suggesting the rules on advice be altered to make for easier transfers from GARs need to be looked at carefully and with some suspicion.

A touch of the Equitables…

In his recent letter to Ros Altmann, quoted in full on my previous blog , Phil Loney of Royal London makes a distinction between GARs and guarantees offered from occupational pension schemes.

We do not, however, believe that this solution should be extended to those with DB pensions. The complexity of these schemes and the nature of the guarantees that apply can only be assessed and communicated by a professional adviser with the appropriate level of qualification.

I think both in the legal and moral senses, Phil is wrong here. As I started this blog by saying, GARs offer a Defined Benefit- which is a pension. The guarantees that come from insurers are – it’s true- more straightforward. They are backed by the stringent regulatory requirements, not just of the FCA and PRA but of Europe’s Solvency rules. Some would argue they are too well reserved – the impact being the low annuity rates in this country (relative to those in the United States- for instance).

The guarantees from an occupational pension scheme are varied in quality. Some of them were worthless- some people got nothing from bust DB plans prior to the Financial Assistance Scheme and its successor the Pension Protection Fund (PPF). Some of them are AAA rated – such as those offered from Government Schemes and from the largest companies in the land. In-between, the chances of the guarantees being paid, depends on an assessment of the covenant from the employer and of an evaluation of the rules of the PPF.

Frankly, to most people a guarantee is a guarantee like a bottle of wine is a bottle of wine. Most people won’t countenance paying £30 for something they can get from £5 – unless they are expert. Arguing that occupational DB plans are so far removed from insurance policies that pay guaranteed income could come back to bite insurers in the bum.

An equitable transfer policy?

The transfer value offered from a “DB pension plan” is based on the value of the benefit given up – a value that is calculated by an actuary. It is calculated on a formula but can be adjusted to reflect the scheme’s solvency (its ability to pay). If an occupational scheme is in deficit, the transfer value may be less than were it fully solvent. All this could (and in my view should) be explained when the transfer value is offered.

But the transfer value offered by an insurance company for its transfers is based on the money that is in the policy that will purchase the annuity – not on the value of the benefit given up. Since the benefit being given up is typically much higher than could be purchased by the money on offer, almost everyone with a GAR is a muppet to use it for cash. This was the point made in the previous blog.

Sacrifice your pension for the good of the insurer?

Phil’s argument to justify Royal London’s position on GARs (outlined above) is posted in the comments column of the previous blog and runs as follows;

We are a mutual so any capital released by lower take up of the GAR option still belongs to customers and flows back to them via our profit sharing mechanic.

I can confirm that Royal London are very good at returning excess profits to policyholders, a practice that is winning them many friends.

But I very much doubt that any of his customers would be prepared to give up 60% of the value of their personal policy for the good of the millions of other policyholder- not to mention the CEO who picked up a bonus last year north of £3.5m.

If Royal London want out of their GARs – and this goes for all other members of the ABI, they are going to have to buy their way out. That means offering transfer values that reflect the cost of the GAR to the insurer, not the money being used to purchase the benefit. After all, that is what the insurer is reserving for.

Pay up or shut up?

I am not saying that Royal London (or other members of the ABI) are lobbying to use the limited protection of Pension Wise to get out of their obligation. In my previous blog I was saying it is better for their customers to be told “don’t be a muppet” for free than to pay £1000 for the privilege.

However I am (now) saying, what I thought about saying a couple of days ago, that Phil is batting on a very sticky wicket (I blame the old uncovered pitches of the 70s and 80s!).

The policyholders who got GARs were generally lucky not skilled purchasers. The GARs were given away by marketing departments keen to get on the selection panels of the large actuarial firms who controlled the AVC market. Some smart policyholders always knew that the GAR offered valuable protection but most didn’t.

If you’ve got a GAR, you now have to be told about it and should be told how valuable it is. If you don’t get advice, then you should be told by Pension Wise who should also guide you to the conclusion but nobody but a muppet lets the insurer off the hook by throwing away the guarantee.

I have a GAR and would like my insurer (Zurich) to make me an offer for the guarantees well in excess of the money used to purchase the GAR.

If the insurers insist – as Phil does in his letter that

Two months into the new pensions regime it is very clear that this policy to safeguard savers with GARs is a failure

then let’s demand that insurers, like occupational pension schemes , have to pay a cash equivalent value for the benefit being given up (the annuity) and not the value of the pot.

That is the logical conclusion that my senior actuary took and I suspect it is the position that any consumer focussed Regulator would take as well.