Articles - The future of UK annuities: Boom or Bust?


Immediately after the budget, the Chancellor’s announcement was widely taken to mean “no-one will buy an annuity” in the future; such as in the US – whose DC market the UK’s might end up resembling – USD 8.7 billion of “traditional” annuities were sold in 2012. This compares with USD 80 billion of variable annuities sold in the same period. It is difficult to imagine an annuity market as large as the UK’s reducing to this extent.

 Paul Sweeting, European Head of Strategy Group at J.P. Morgan Asset Management
  
 But if we look to New Zealand, whose annuity market has collapsed completely, we can see a precedent. Conversely, annuities remain popular in Switzerland, despite the lack of compulsion. It is also worth looking at how the annuity structure might be revisited, exploring Denmark’s ATP for an alternative view.
  
 New Zealand – the Death of Annuities
 In 1993, there were nine providers of annuities in New Zealand; by 2013, the last provider left the
 market, having sold only a single policy over the previous year. A number of factors contributed to the collapse of New Zealand’s annuity market, including the bequest motive, as well as a higher tax rate on annuity assets compared to alternative investment vehicles.
  
 In addition to this, in 2001 the New Zealand Superannuation Fund (NZ Super) was created to provide a basic level of income for all individuals that have lived in New Zealand for at least ten years, of which at least five should be since age fifty. In the 2014-5 tax year, NZ Super provides gross weekly payments of between NZD 302 and 421 per week, or NZD 15,704 to 21,892 per annum. This is equivalent to around GBP 8,000 and GBP 11, 200 per annum. As such, individuals have a guaranteed life-long income that keeps pace with inflation, and even adjusts with lifestyle. With a guaranteed income, why would you buy an annuity?
 This is relevant as the UK Government is introducing a similar single-tier pension from April 2016 of around GBP 144 per week, or 7,488 per annum. At a similar level to the pension paid by NZ Super, and may similarly discourage annuitisation in the UK.
  
 Switzerland – Voluntary Annuities that People Buy
 In Switzerland, part of employer-related pension provisions is a cash balance arrangement, funded by employer and employee contributions. Whilst annuitisation is often optional, more than half of Swiss retirees choose to annuitise fully at retirement, despite the lump sum alternative being subject to lower taxation.
  
 The annuity conversion rate is generous. The annuities available also offer good benefits for spouses and children, overcoming fear buying an annuity may limit assets left to the next generation. But the fact only a minority of Swiss citizens own their homes outright might also be an issue, with annuity income providing a match for rental or mortgage payments.
 This is particularly relevant to the UK where house prices remain high compared to average incomes, making it is less likely mortgages will be paid off by retirement. Therefore, might there be a future for UK annuities?
 
 Denmark – Share and Share Alike
 The Danish ATP (Arbejdmarkedets Tillægspension) is a supplementary earnings-related DC plan with fixed contributions. Out of each contribution, 80% is used to purchase a “slice” of deferred annuity, the remaining 20% of each contribution is used both as a buffer against adverse movements in longevity and financial markets, but also as a way of funding increases to both deferred annuities and annuities in payment.
  
 This use of the remaining 20% is important, and contrasts with the way a typical insurance company would operate. An insurer would also hold risk capital to protect against adverse events, though the proportion of the premium used for this would probably be lower than 20%; however, if the risk buffer were not needed, the capital would revert to the insurer as profit rather than being distributed to the policyholders. Could an alternative, collective approach provide better outcomes for policyholders?
  
 The Future of Annuities – The Collective Deferred Approach
 Annuities may no longer be known under this name, but they will likely still be provided by an insurer. However, the key focus will now be placed on flexibility. It is unlikely the annuities market will disappear as it did in New Zealand – the New Zealand experience is driven to a large extent by the tax regime for annuities in that country; in the UK, annuities are not similarly disadvantaged. The Swiss outcome is perhaps more likely – particularly given the continued growth in house prices – but the single tier pension in the UK will go some way to providing a guaranteed level of income.
  
 Furthermore, using the Danish approach to collectivising the risk could provide more generous benefits in old age, with unused risk capital being redistributed rather than reverting to the insurer as profit.
 
  

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