Billy Burrows on the storm brewing for annuities

With annuity rates hitting 20-year lows, people reaching retirement age face a stormy future, writes Billy Burrows, director of Better Retirement Group.

Annuity rates have been falling almost continuously since 1990, the year in which I first started keeping records of them. In 1990, the annuity rate for a 65-year old man was more than 15.5%; today it is less than 6.5%, a fall in excess of 50%.

Back then the yield on 15-year gilts was greater than 11%; today it is around 3%. And inflation in 1990 was 10% plus, whereas today it is around 5%.

However during August 2011 annuity rates hit their lowest levels since 1990 and matters were made worse because of the so-called double whammy of falling annuity rates and falling equity prices.

In August, annuity income fell by more than £300 per annum, or 5%, making this the largest monthly fall on record. During the same period the UK stock market fell by 9%.

Flight to quality

So what caused this huge fall in annuity rates and what are the prospects for annuity rates in the future?

The main reason for the sudden reduction in yields is the flight to quality resulting from the European and US debt problems. At times when investors are worried about global equities there is a strong demand for gilts. As the price of gilts rise, the yields fall. UK gilt yields are at their lowest level for many years.

The situation is somewhat strange because the UK has its own debt problems, but it seems that global investors think it is not as bad as in other countries.

Unfortunately there seems little sign of an end to the current period of volatility as bond yields and equity prices continue to be volatile. I would like to predict an Indian summer for those approaching retirement but we fear more storms could be on the horizon.

The Sword of Damocles

The most intelligent prediction is that bond yields will rise over the next few months but the full benefit of any rise will probably not be passed through to annuity rates as there is usually a time lag between rising yields and rising annuity rates.

The Sword of Damocles – in the form of gender neutral annuity pricing, the new Solvency II rules and increased life expectancy – hangs over annuities so it is unlikely rates will increase significantly in the short term.

Towards the end of 2012 there is a perfect storm brewing in the annuity market as Solvency II and unisex annuities collide.