Preserving the golden age of annuities

Steve Groves, chief executive of Partnership, discusses the opportunities and problems surrounding the scrapping of the annuity age.

We congratulate the Government on its consultation, Scrapping Annuities Age 75, which provides a range of retirement funding options to meet its objectives of ‘making savings…more flexible and attractive in order to encourage people to take greater responsibility for their financial future’. However, there are significant issues it must address or at least one golden opportunity may be lost.

First, the continuing and enduring benefits of annuities must not be overlooked. For many people in retirement, an annuity, which provides a guaranteed income for life, will be the best product. The benefits of a guaranteed income from an annuity should be set against both the cautionary background of the recent catastrophic failure of equity markets and the explosion in life expectancies seen since the mid-1970s.

This consultation also provides an opportunity to ensure the 80% of people in retirement with pension pots of less than £30,000 that currently default into poor value annuities can genuinely exercise their choice to increase their income in retirement by shopping around for the best annuity rate (known as the OMO – Open Market Option).

Shop around for best rate

It is an enduring public-policy scandal that after 20 years, only one in three people shop around for the best annuity rate, with most defaulting into lower rates from ceding providers. (Partnership’s data shows that internal annuity transactions account for 62% of all annuities in 2009.)

This is despite the fact that many people might benefit from increased retirement incomes of up to 20% for life. This can be more, if they are among the 40% of people who are eligible for an enhancement for reasons of a medical or health condition. However, only 12% of people purchase enhanced annuities.

The scale of the problem is significant and does need to be addressed urgently. Partnership’s figures suggest most average men and women retiring in the UK today can look forward to a State pension of less than £6,000 per year, plus a private pension of around £2,000 a year (in this latter case, equivalent to £40 per week).

In particular, this consultation offers the Government the opportunity to ensure that all providers give a proper ‘wealth warning’ to potential annuitants, highlighting not only 1) the annual amount they will offer the potential annuitant but 2) a comparison to the best ‘Open Market Rate’ that annuitant would be entitled to. The emphasis must be on the potential annuitant agreeing that they will accept responsibility for receiving less retirement income for life. They should also be notified that if they have a health condition they may be eligible for far more income.

We also support the Pensions Income Choice Association (PICA’s) ‘Pension Passport’, which seeks to counter poor awareness of the OMO and to address the annuity process, which is perceived to be slow and complicated with a simple and easy to use form to help people at retirement to shop around for the best retirement income.

These actions will not only benefit these pensioners, who are usually among the poorest people in the UK, but it will also have a profound impact of the Government’s exposure to means tested benefits.

Changing retirement needs

Another challenge which must arise from this consultation is the need to ensure that the Minimum Income Requirement (MIR) is maintained at a ‘healthy’ level for changing retirement needs, including long-term care.

The needs of people in retirement will change significantly over the next decades. This must be reflected in the MIR. The most significant impact will be among people aged over 85, who are now set to increase by more than 60% in the next 20 years and people aged over 75 who will increase by about 70% in the same time period (Laing and Buisson, 2009).

Partnership is the largest provider of long-term care insurance in the UK. It recognises the importance of the need to find sources of funding for domiciliary care and residential care, which can be significant, with typical fees for many high-quality care homes being £50,000. We have estimated that self-funders (those people with more than £23,250 in assets including property) who have depleted their capital prematurely and have had to fall back on the State costs local authorities in England alone nearly £1bn a year. Clearly, any MIR should take account of these new but no less important funding elements.

Drawdown models

We welcome the capped and uncapped drawdown models and believe that the decision to put choice back in the hands of individuals is a very welcome step. We will be watching to see how the capped drawdown limits post-age 75 reflect the very real risk a person may live through several investment crises and live beyond the age of 100 years.

Our stochastic models, which we look forward to providing in our response to the Consultation, demonstrate how cautious one needs to be in setting the limits for this capped ­drawdown ­category if the objective is to avoid people exhausting their funds. This is no surprise given the type A critical yield on a standard 75-year-old going into drawdown is usually 10%-12% when the best OMO annuity rate is used.

Finally, and arguably one of the most important opportunities for the industry that this consultation provides is for the industry to start reflecting some of the benefits envisaged within the consultation paper in a ‘capped drawdown’ scenario within annuity products.

We would welcome the opportunity for annuities, which provide a guaranteed income for life, to also provide ‘commutation’ options, where annuitants can defer income to a later phase of their retirement to meet their changing needs or indeed accelerate future income to today provided the MRI floor on the remaining annuity benefit is not breached.

Guaranteed income benefit

The older a pensioner becomes, the greater their needs for more income to cover the costs of domiciliary care and residential care. This innovation will not just provide the comfort of guaranteed income but the flexibility to manage their retirement income to meet their needs.

An increase in the range and type of guaranteed financial product for people in retirement will be a very welcome and possibly unforeseen benefit of this consultation. This should certainly help encourage more people to save for their retirement while providing much needed safeguards against asset volatility and ever-increasing longevity.

In summary, this consultation offers significant opportunities respectively for both consumers and the annuity industry in providing appropriate wealth warnings and offering the industry the opportunity to innovate. Against this must be balanced the risk that when assessing responses that the Government fails to place due weight on the enduring value of annuities to consumers, or fails to set an MIR that recognises the speed at which capital can be exhausted in capped drawdown or the many demands which can be placed on individuals as a result of increased longevity, such as meeting the costs of care.

By understanding these opportunities and challenges, the Government will be best prepared to ensure that options for retirement savings remain flexible and attractive and encourage people to take greater responsibility for their financial future. This is the key objective for the Government which underpins this consultation.