According to Royal London, we’ll be able to buy and sell each other’s annuity payments from next April. Presumably this article is on pre-release as I read April 2017 but who am I to argue with “Batman” Phil Loney or “Robin” Steve Webb?
Like Royal London, I’m pleased as punch that there will be a market for unwanted annuities and that people who – for whatever reason- would rather have capital than lifetime income, can make that choice.
Philosophically, people stopped believing the money in their personal pensions and their defined contribution pension schemes was “theirs” and this happened because they had no say in how they could spend it. The decision was taken by Government, an insurer, an annuity broker. It was not something that they had much choice about. Indeed if people tried to break free and buy a drawdown policy, they were knocked back and told they hadn’t enough money. In short- the business of spending their retirement savings had become degrading and was seen as a rip-off by millions of policyholders.
This has changed with the abolition of the tax-rules that forced people into purchasing annuities and this has been generally accepted as a step in the right direction. People now buy annuities out of choice and not out of reluctant acceptance the they are the rule.
Not many people are choosing annuities. This is partly because they are too expensive (according to Alan Higham, 20% more expensive than in the US). People don’t get that they are too expensive because of the higher quality of the guarantee. For most people a guarantee is a guarantee, the credit rating of a promise is not a concept that most people understand.
The memory of the Equitable Life’s near collapse (because of the lack of credibility in its guarantees) is becoming a distant memory but the truth is that if you are an annuitant in the UK, you hold a promise that is of a better quality because of the Equitable. This – I am sure – will be recognised in re-sale prices.
We didn’t know what we were buying
Not only are our personal annuities very high quality, they are very much in demand. Many employers need a way to buy their way out of their obligations to their retired workers to whom they have made promises. Currently there is no currency that pays off these promises. The second hand annuity market creates that currency and provides liquidity that frees up companies and charities – to do what they need to do- which is generate profits or do good works. Of course, in the short term, getting the promises off their balance sheet is going to be expensive and might put a blip in plans, but if we can get DB scheme liabilities transferred to insurance companies using the secondary annuity market as a lever, then in the long term this is good for the economic and social fabric of the company.
Finally there is a more deep rooted issue, the question of how much responsibility we can be allowed to take for our financial condition. The old paternalistic world where we worked, got pensioned and died is dead. We live longer, work shorter and we have much more wealth (relative to other generations). While we may not be wiser, we certainly have more scope to take choices and the Government’s big challenge is to free up choice and give us the means to make informed choice.
Part of this must be to give us choice to exchange the old annuity for some kind of new annuity which pays more with less certainty. Along with discussions on how we can sell out of the old, we need discussions about how we can buy the new. I’m encouraged by recent noises from Brussels that suggest that the stringent solvency rules that have made the cost of providing insurance in the UK so expensive , are being relaxed. If Solvency can be eased, we may be able to bring back guarantee light annuities which do what I hoped CDC could do, provide a target pension at a higher rate with an acceptable level of security.
When the Pension Freedoms were announced, I wrote that I feared for the millions who had bought annuities through the period of depressed interest rates. For them, the annuities would pay too little and would be seen as an unnecessary encumbrance, a loss of freedom denied to others. The secondary annuity at least addresses the loss of freedom. Sadly there is no way to make those annuities as valuable at resale as they were at purchase and people will lose in the sale. They will have to accept that like a house, the value of an annuity can go down as well as up.
At least we’ll find out what we’re selling!
But in working out how annuity prices work, people will at last be engaging in the key issues- longevity, the impact of long term interest rate expectations, the risk of investing in gilts and the risks of investing in other assets. People will – because of a secondary annuity market – start to understand pensions – as they understand other markets – the housing market being the obvious comparator.
It will take a generation for the problems we have created to work out. Many of us saw the train coming round the corner and watched as it hit the buffers. We are now watching as the casualties emerge from the carriages and it won’t be pretty. From April 2017, we will see people having brutal conversations about annuity valuations, but at least these conversations will be in the open.
Transparency is the great disinfectant, but disinfectant- when applied to an open wound- can be painful. It is however the only way we can recover.
I doubt, when people understand what they bought and what the alternatives are, that many annuitants will sell – but it only takes 10-20% to create a liquid market that benefits defined benefit schemes and those who run them , allows those with need for capital to have it and enables the few who really know what they want to exchange the old annuities for the new.
Who knows, there may even be a new default emerging from this – a default which people who don’t want to take decisions, can find does pretty much what they want pretty much all of the time.