Will it all blow up?

Another great guest blog from Ralph- keep them coming Ralph – your reader stats are awesome!(Pension Plowman)

The seemingly inexorable march towards the creation of a secondary annuity market passed two significant milestones last week.  HMRC published a consultation covering the tax framework proposed for the market.  The following day, the Financial Conduct Authority (“FCA”) published a related consultation paper combined with proposed rules and guidance for the operation of the market.  These publications were issued despite Government acknowledging that “for most people retaining their annuity will be the best choice as it provides a regular, guaranteed income for life”.

The scope of annuities eligible for conversion into a lump sum has widened since the proposals were first launched, alongside the 2015 Budget.  At that point, only annuities held outside an occupational pension scheme were included in the proposals.  This categorisation effectively meant that Defined Contribution (“DC”) and Defined Benefit (“DB”) pensioners whose benefits had been transferred from an occupational scheme to an insurer were set to benefit from freedom and choice.  This approach created an inconsistency of treatment across DB savers.

The HMRC consultation now includes annuities held within a scheme but assigned to members as eligible for sale.  This change leaves members of DB schemes who receive pensions from the scheme, but where there is no annuity backing the pension, unable to participate in freedom and choice.  The situation could arise within a DB scheme where two members with the same pensions could be subject to materially different treatment if one’s pension is backed by an annuity while the other is not.  The former will be able to convert their income stream into a lump sum while the latter will not.  However, the annuities remain an asset of the scheme.  Should, for example, the scheme enter the Pension Protection Fund (“PPF”) then the income stream being paid to the pensioner might be affected (due to the PPF’s limit on increases to pensions in payment).  This scenario will likely impact the price offered for pensions in payment arising from schemes at risk.

The PPF case, as unattractive as it is, is relatively straightforward compared with other scenarios that might arise if the freedom and choice changes are consistently extended across the DB market.  Sadly, this mushrooming mess was completely avoidable had the base policy been fully thought through ahead of being announced.  Pandora could only have dreamt of opening a box like freedom and choice!

The FCA recognises that “there is a significant risk of poor outcomes for consumers in the secondary annuity market” and has consequently proposed a series of seemingly sensible safeguards.  However, if a party simply making an initial enquiry about a transaction is to be met with eight risk warnings, is it really that sensible to be offering the transaction in the first place?  I suspect that compliance managers are going to lose sleep over this proposed new market while lawyers and claims management companies are getting increasingly excited ahead of the proposed opening of the market next April.

An annuity in payment has a finite value.  The consideration to be received in respect of a sale is going to be eroded by a range of costs including those related to brokers, underwriting costs and those arising from the insurer making the payments.  All of these costs are to be disclosed under the terms of the consultation.  The FCA has proposed that the replacement cost of the income being sold be quantified through the provision of a quote for a fresh annuity delivering the same income.  This proposal will more than highlight these costs.  The fresh annuity will include set-up costs of its own, widening the disparity between the value of the income stream and the lump sum offered on sale.  These safeguards are likely to reduce the level of secondary annuity sales ultimately transacted.

Both the Government and FCA recognise the material risks that a secondary annuity market represents and the relative unattractiveness of the facility, yet they are charging ahead with bringing the market to fruition.  The effort, and related costs, in consulting on the market and bringing it to life are non-trivial.  I suspect the resources being absorbed in this project might well have been more productively deployed elsewhere.  Providers are still struggling to catch up with the first phase of freedom and choice, let alone take on subsequent phases.  The cost and effort of setting up the market needs to be considered in the context of the relatively small number of annuitants likely to benefit from the facility.  What is the real driver behind the dogged intent to set up this market?

The seemingly inexorable march towards the creation of a secondary annuity market passed two significant milestones last week.  HMRC published a consultation covering the tax framework proposed for the market.  The following day, the Financial Conduct Authority (“FCA”) published a related consultation paper combined with proposed rules and guidance for the operation of the market.  These publications were issued despite Government acknowledging that “for most people retaining their annuity will be the best choice as it provides a regular, guaranteed income for life”.

The scope of annuities eligible for conversion into a lump sum has widened since the proposals were first launched, alongside the 2015 Budget.  At that point, only annuities held outside an occupational pension scheme were included in the proposals.  This categorisation effectively meant that Defined Contribution (“DC”) and Defined Benefit (“DB”) pensioners whose benefits had been transferred from an occupational scheme to an insurer were set to benefit from freedom and choice.  This approach created an inconsistency of treatment across DB savers.

The HMRC consultation now includes annuities held within a scheme but assigned to members as eligible for sale.  This change leaves members of DB schemes who receive pensions from the scheme, but where there is no annuity backing the pension, unable to participate in freedom and choice.  The situation could arise within a DB scheme where two members with the same pensions could be subject to materially different treatment if one’s pension is backed by an annuity while the other is not.  The former will be able to convert their income stream into a lump sum while the latter will not.  However, the annuities remain an asset of the scheme.  Should, for example, the scheme enter the Pension Protection Fund (“PPF”) then the income stream being paid to the pensioner might be affected (due to the PPF’s limit on increases to pensions in payment).  This scenario will likely impact the price offered for pensions in payment arising from schemes at risk.

The PPF case, as unattractive as it is, is relatively straightforward compared with other scenarios that might arise if the freedom and choice changes are consistently extended across the DB market.  Sadly, this mushrooming mess was completely avoidable had the base policy been fully thought through ahead of being announced.  Pandora could only have dreamt of opening a box like freedom and choice!

The FCA recognises that “there is a significant risk of poor outcomes for consumers in the secondary annuity market” and has consequently proposed a series of seemingly sensible safeguards.  However, if a party simply making an initial enquiry about a transaction is to be met with eight risk warnings, is it really that sensible to be offering the transaction in the first place?  I suspect that compliance managers are going to lose sleep over this proposed new market while lawyers and claims management companies are getting increasingly excited ahead of the proposed opening of the market next April.

An annuity in payment has a finite value.  The consideration to be received in respect of a sale is going to be eroded by a range of costs including those related to brokers, underwriting costs and those arising from the insurer making the payments.  All of these costs are to be disclosed under the terms of the consultation.  The FCA has proposed that the replacement cost of the income being sold be quantified through the provision of a quote for a fresh annuity delivering the same income.  This proposal will more than highlight these costs.  The fresh annuity will include set-up costs of its own, widening the disparity between the value of the income stream and the lump sum offered on sale.  These safeguards are likely to reduce the level of secondary annuity sales ultimately transacted.

Both the Government and FCA recognise the material risks that a secondary annuity market represents and the relative unattractiveness of the facility, yet they are charging ahead with bringing the market to fruition.  The effort, and related costs, in consulting on the market and bringing it to life are non-trivial.  I suspect the resources being absorbed in this project might well have been more productively deployed elsewhere.  Providers are still struggling to catch up with the first phase of freedom and choice, let alone take on subsequent phases.  The cost and effort of setting up the market needs to be considered in the context of the relatively small number of annuitants likely to benefit from the facility.  What is the real driver behind the dogged intent to set up this market?