Judging by the stock market’s reaction to this week’s budget speech, the UK’s £12bn Individual Annuity market is set to collapse.
As the Chancellor spoke, life sector share prices went into free fall. Within 90 minutes Friends Life were off 14.6%, Legal & General had dropped by 13.2%, while Aviva, Guardian, Standard Life and Prudential had all fallen by between 2.5% and 7.5%. Over £40bn was wiped off the combined market value of these six insurers.
The damage done to the specialists, Partnership and Just Retirement, was far more dramatic. At one point Partnership’s share price had halved.
Annuity sales are profitable for life insurers and particularly so when sold to existing customers. With some justification the FCA has observed that the annuity rates offered by insurers to their existing savers are often far less attractive than those available on the open market. Both the Regulator and the Treasury are intent on radical market reform. So there will clearly be change; but will the loss of profits be of the scale suggested by the market’s immediate reaction.
Annuities have been in trouble for some time. Quantitative Easing has resulted in global interest rates dropping dramatically. Correspondingly and unavoidably the rates on offer from annuity providers have become unattractive. Poor value for money has caused many to defer the conversion of their pension savings into a retirement income. Under the Chancellors proposals many more people will be able to defer the purchase of an annuity because they will be able to draw an income, effectively, out of capital. There is no question that for those who can afford to put off taking an annuity should do so, but taking income from capital is an illusion. Once spent this money is gone. Cautious pensioners will hesitate.
The annuity market has been going through something of a transformation. Just as the motor insurance industry was irreversibly altered in the 1980’s when Direct Line started underwriting each of us individually in order to set the premium we would pay for our car insurance, so now an increasing number of insurers are applying actuarial science to divining for how long we can be expected to live.
The specialists in the annuity market, Just Retirement and Partnership, have taken this approach a step further by offering higher pensions to those suffering from critical illnesses. These companies are innovators. They serve a particular part of the market which has grown rapidly. Their products will continue to be in demand.
Additionally the life insurers are shifting their attention from the individual annuity market to providing bulk annuities to those large companies which have the funds and are eager to transfer the liabilities of final salary pension schemes off balance sheets.
Last year £5.6bn of bulk annuities were written in the UK. This year the market is set to be between £12bn and £15bn. The growth in this market will more than make up for the predicted loss of revenue from a shrinking individual annuities market; and of course the individual annuity market is unlikely to disappear!
Around 700,000 individuals retire every year. The number of annuities taken out in the open market last year was little more than 100,000. Those buying annuities’ today are almost certainly buying them because they need to. They would otherwise struggle to meet their living expenses. The number of people purchasing annuities will grow once interest rates start to rise.
The history of financial markets tells us that as the rules change, products adapt. People will continue to seek certainty that, in their old age, they will have sufficient income. The management of a portfolio of investments requires a sophisticated knowledge of markets and a good deal of investment skill. Not many individuals have the requisite knowledge or expertise, let alone the confidence to run the risk of getting things wrong. Even if an individual plays the markets well, life expectancy is accelerating at an unprecedented rate. An annuity insures an individual against outliving their assets. Expect to see the price of insurers come back over the days to come.