The “annuity puzzle” and how to solve it.


Have you noticed how TV drama focusses on dying? We’re obsessed with death. Statistically the county of Midsomer should be totally depopulated by 2050, such is the carnage wrought on its citizens. We mark each celebrity , friend who dies. Our news broadcast focus on the loss of life. Our obsession with our ending overshadows the fact that we are still living and most of us are showing no sign of dying.

We spend time in the gym, we walk the hills , we diet and we avoid toxins to avoid death. Yet we still bet on our dying sooner than later.

This fact is we do not want to insure against old age because old age is not in our imagination. Everything we are doing in this massive attempt to stay young, is in denial that we will grow old.

I am not surprised by the findings of the IFS. Paul Lewis comments

He is partly right, but the propaganda is populist, there is a pre-existing bias in our psyche towards nostalgia and we yearn for youth rather than preparing for the future.

Death is so much more glamorous than living long. Death doesn’t just sell TV drama, it stalks our imagination, a real foe against whom we fight to be rewarded with the one thing we have no plan for – a long older life! This is so curious. It is what the Institute of Fiscal Studies calls “the annuity puzzle“.

A conspiracy against annuities?

Picking up Paul’s theme about “propaganda”, and continuing my musing on murder mysteries, I’m looking for a motive.

Why has everyone from George Osborne to the Wealth Management Industry got it in for annuities?

Research from the mid nineties on (Orzag + Orzag +Mehta) shows that annuities purchased in the UK are value for money products. They are well priced , there is a competitive market and for the certainty they offer, they provide a decent income in exchange for the capital used to purchase them. The research consistently shows that annuity providers are not ripping off their customers.

When George Osborne said that nobody need ever buy an annuity again, he raised the roof of the house of commons, we all dislike a product the point of which is to fund the part of our life we don’t want to think about.  But the product is sound, it does what it says on the tin. I wrote recently about work Legal and General have done on annuities which shows again that the problem is not with annuities, but with people’s failure to engage with the reality of the future.

I think that this unstated bias against protecting ourselves against old age is built in to much of the objections to CDC. If only 12% of us are purchasing an annuity with any of the money we have at retirement, why should 100% of us choose to club together and insure ourselves against living too long? Do we want longevity protection – 88% of us clearly don’t see this as a priority.

Do we need longevity protection? Well we are likely to hear within the next few weeks more bad news about the state of long-term healthcare and the vital need for us to do some planning to afford the implications of a long demise.

If our answer to this problem is to blow our pension pots in our sixties and seventies, then DC is presenting the next generation with a massive problem. The moral hazard is obvious, we are presenting our children with a long-term care bill that can only be met from their inheritance or for a levy on the wages of those still working. Either way our children will have to pay for our healthcare – unless we make provision today.

Mortality pooling prevents inter-generational transfers.

My conclusion is that ordinary people cannot afford annuities any more than ordinary private companies can afford Defined Benefit pensions. The cost of guaranteeing the future is too great, a lower level of certainty must be admitted or people give up altogether.

The lower level of certainty I am thinking of, is of course the unguaranteed wage for life offered by a properly managed CDC plan.

If we cannot afford “proper” pensions , we cannot afford not to insure against old age either. The annuity puzzle presents this paradox but no answer.

CDC presents an answer, albeit one that depends on a belief that over time – maintaining the funding of unguaranteed pensions depends on investing in growth assets rather bonds, keeping admin and investment costs down through economies of scale and ensuring that new people arrive into the retirement pool to replace those dropping off the perch.

This is what Royal Mail are doing with a pool of around 140,000 postal workers. It is a noble experiment that will need to be emulated by other organisations if we are to call CDC anything more than an experiment.

Without such an experiment, I see little chance of individuals changing their behaviours much, people will continue to vote against annuities nine to one and we will have as a nation no plan as to how to spend the massive sums we are saving into DC workplace pensions.





About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
This entry was posted in pensions. Bookmark the permalink.

1 Response to The “annuity puzzle” and how to solve it.

  1. Peter Ellis says:

    Henry, maybe its the notion that customers would use only one product rather than another that needs examining. For many using a portion of available assets to secure longevity protection may well be appropriate, with the actual proportion being based on individual circumstances including other sources of income that continue until death. After all, a typical drawdown portfolio will consist of a number of asset classes to match a customer’s risk profile, why shouldn’t such a portfolio include an element of an asset class that provides guaranteed lifetime income. Indeed if this were the case, it may actually enable the remaining invested portfolio to include a higher proportion of the growth assets you refer to, which would in turn provide for the inter-generational transfer of assets that many hope to achieve

Leave a Reply