Advisers turn to asset-backed annuities as rates plunge

Advisers are set to turn their backs on conventional annuities and recommend asset-backed alternatives as annuity rate crashes continue to plague retirees.

A study conducted by MGM Advantage suggests more than 90% of IFAs expect the market for asset-backed annuities to grow over the next five years.

The research, which collected the views of more than 40 independent advisers, also found 82% expect conventional annuity rates to fall during the same period.

Last month, ten-year gilt yields hit an all-time low after the Bank of England warned of a double-dip recession, dragging annuity rates down with them.

Between July and August, two-year annuity incomes slumped on average from £19,863 to £19,344 for a 30-year-old and from £10,824 to £10,466 for a 60-year-old, according to Aon Consulting.

Billy Burrows, partner at Burrows Cummins Annuities, says clients realise rates are falling and should be eyeing asset-backed annuities, but “don’t want to take a risk”.

“There is already a great deal of interest in asset-backed annuities and increasingly people are looking at splitting their assets, putting half into an asset-backed annuity,” he says.

Burrows says clients tend to avoid asset-backed annuities because of the low starting incomes and perceived higher risk. But he says pensions are “long term” investments and the key for advisers and clients would be to remember that.

Solvency II, a review of the capital adequacy regime for the European insurance industry, is another reason why advisers are recommending clients look at asset-backed alternatives.

Darren Dicks, head of annuity propositions at Aviva, says: “Solvency II forces insurers to hold more capital to cover their liabilities, so this could push rates down. With asset-backed annuities, the customer holds the risk, so the rates could be higher.”

Dicks emphasises the need for the risk of asset-backed annuities to be explained to customers, and adds these products are only suitable for some investors.

“This is a market that is increasingly moving in the right direction; research with advisers and customers as to whether asset-backed annuities would be attractive has been positive, so watch this space.”

However, Bob Bullivant, chief executive of Annuity Direct, does not think asset-backed products will become “mass sellers” because they are only suitable for certain investors.

He says: “You need a growth rate of at least 7% to beat a normal annuity. Insurers need to cut their charges to compete; normally there is a reduction yield of 2%, so a growth rate would have to be 9% to provide a comparable income to an ordinary annuity.”

What are asset-backed annuities?

Asset-backed annuities differ from level or increasing annuities as they are linked to fixed interest assets like gilts and bonds. This means incomes from asset-backed annuities might go up or down, by any amount, as they are dependent on the stock market.

• With-profits annuities – these link the member’s income to the providers with-profits fund. The income is split into a minimum starting income, which is guaranteed from the outset, and bonuses, which are usually announced once a year and paid out for the duration of the annuity.
  
  
• Unit linked annuities – the member’s income is linked to the value of an underlying fund of investments. Members can choose which fund they prefer, from medium risk, higher risk and a tracker fund which tracks the performance of a stock market index such as the FTSE.