Annuity Update – March 2012
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After 6 months of depressing news about annuity rates it seems that we have the left the bad news behind us; or have we?
The reason for optimism is that yields on 15 year gilts have increased from an all-time low of just below 2.5% at the beginning of 2012 to just under 3% in the middle of March. This 50 basis point increase should translate into about 4% increase in annuity rates but annuity rates have only increased by a small margin.
Although it is early days this does support my prediction that annuity yields would rise, but the full increase would probably not be passed to annuitants.
Why isn’t the full impact of the hike in gilt yields being passed on to annuitants? First there is the obvious time lag; normally nothing happens quickly in pensions. Secondly there are only three companies offering competitive standard (normal health) annuities so there is not as much competition as we would like. These companies are Aviva, Canada Life, and Legal & General.
There is more competition for enhanced annuities with companies such as Just Retirement, LV=, MGM and Partnership, in addition to the three already mentioned paying higher incomes for those with a lifestyle or medical condition which may reduce their life expectancy.
To qualify for an enhanced annuity, investors will need to able to answer yes to one of the following questions:
- Do they smoke?
- Are they taking prescription medication?
- Have they been to hospital recently for a medical condition?
Unlike the standard annuity market, the enhanced annuity market is very competitive. However investors need to be on their toes because whereas the standard annuity market is completely transparent, the same cannot be said for the enhanced market so customers really do need to seek an expert help in order to secure the best rates.
Sword of Damocles
The third reasons why those approaching retirement should not hold their breath in anticipation of a significant rise in annuity rates is the “Sword of Damocles” in the guise of Solvency II and gender neutral annuity pricing.
Solvency II is a complex piece of EU regulation that will result in life companies setting aside more capital to support their future liabilities. If annuity companies have to put more capital aside to finance their annuities it will inevitably result in lower incomes. This is one of the reasons why Prudential is considering moving its HQ overseas.
Gender neutral annuity pricing means exactly that. The rates for men and women will the same despite the obvious difference in life expectancy. It’s hard to see who will benefit except for single ladies as married ladies will lose out from the lower income from joint life annuities.
Both measures will kick in from beginning of 2013 and although the effects on annuity incomes is unknown it is likely to be less than the 10% -20% reduction that appears in some headlines but it will have a negative effect.
Annuities at a tipping point
In the unlikely event that there is a significant cut in annuity rates as the year progresses there must surely come a point when guarantee annuity rates can no longer be thought of as the default option at retirement. Some commentators argue that we have reached that point already and those with above average pension funds should consider the investment linked alternatives.
In conclusion, I think annuity rates have reached the bottom of the current cycle and we may see some very small increases until the double whammy of Solvency II and gender neutral pricing kick in at the end of the year.