JLT Employee Benefits' Richard Williams weighs up the pros and cons of launching a consumer annuities market following the pension freedoms introduced in 2015.
These proposals aim to extend the pension freedoms and flexibilities to those who retired prior to April 2016 and bought an annuity policy.
Pension freedoms should be widely supported. Retirement savings are after all the property of members, who are best placed to understand their individual circumstances and use these savings as they desire.
So, is a secondary annuity market a good idea?
As with all things, there will be circumstances where it will be in an individual’s interests to exercise their right to these newfound freedoms.
The Financial Conduct Authority, however, says there is a "significant risk" of poor outcomes for consumers, and that those able to participate in this annuity market will include a higher proportion of older, more vulnerable individuals.
[Individuals] should ensure they understand that selling their annuity policy could fundamentally change the set of risks they run in retirement
When considering whether to sell an annuity policy, individuals should not only look at the promise of a (potentially substantial) lump sum, which on the face of it can often look to be an attractive proposition. They should also ensure they understand that selling their annuity policy could fundamentally change the set of risks they run in retirement.
These days, retirement is more often seen as a phased journey rather than a cliff edge single event. With increased longevity, there are likely to be at least two phases to retirement:
Phase 1: The first 20 or so years after retirement, where good health is more likely. Many retirees will remain active, still having material outgoings both for their chosen lifestyle and for dependants.
Phase 2: The remaining period of their life, which could be short or long, but is likely to be characterised by increasingly poor health.
Existing annuity policies could continue to be an appropriate savings product, offering long-term protection they may need in retirement.
There are also material risks around the flexibility and savings being used in phase 1 of retirement, leading to materially reduced incomes, lifestyles and the ability to contribute towards healthcare costs in phase 2.
They should also consider whether the lump sum being offered represents good value.
Most individuals would find it challenging to place a value on their annuity income, particularly with increased longevity and low current interest rates. Initial estimates suggest that an individual may lose between 30 per cent and 50 per cent of the value of their annuity policy by exercising freedoms, this difference being made up of expenses, advice charges and insurer views on health.
How could this work effectively?
For the market to work effectively, and for consumers to be protected from poor outcomes, a robust, compulsory process should be required. This would include:
Regulated advice being made mandatory, at least for annuities above a certain level.
Firms required to give those considering the sale of their annuity specific risk warnings and to recommend they seek regulated financial advice or guidance from Pension Wise; also encouraging sellers to shop around.
Brokers required to set out their charges upfront and agree them with the individual selling their annuity, rather than being paid by commission from firms acting as buyers.
The replacement cost of the annuity income, if it were to be bought new on the open market, should be presented to the member alongside the offer being made. This would make it clear to an individual the value they are giving up by selling their annuity policy.
Annuity providers only being able to recover reasonable costs when charging to facilitate annuity income sales.
It is estimated that up to 5m people receive payments under pension annuities. As has been evidenced with the introduction of pension freedoms in 2015, we would expect substantial initial activity.
The concept has merit, and will suit some individuals, however a robust regulated process needs to be in place to ensure they do not sleepwalk into making a catastrophic, irreversible decision that could detrimentally impact the rest of their life.
Richard Williams is a director at consultancy JLT Employee Benefits
