The Chancellor announced in the Budget on March 19th the end of the need for pension savers to annuitise Defined Contribution pension savings. From April 2015 anyone who is aged 55 or over will be able to take their entire pension fund as cash– although only the first 25 per cent will be tax-free. The remaining 75 per cent of the fund would be taxed at the saver’s marginal rate. The market reaction was swift: the shares of the largest annuity writers fell substantially, wiping £6bn off the UK insurers’ market capitalisation. The market fear was the loss of a substantial proportion of the £12 billion a year that is placed in annuities and the resulting loss of new business value, which for many UK life insurers equated to in excess of 50% of total new business value in the UK.
While undoubtedly the number of annuities sold will decline, the impact on the market is likely to be more nuanced. Indeed a case can be made for a positive outcome, with the budget encouraging long term savings. The ISA limits have increased to £15,000, the Premium bond limit has been raised, a 'Pensioner Bond' will be introduced and the 10% tax rate on savings has been eliminated. In addition, some people have been put off saving into a pension due to the requirements of buying an annuity that was either perceived to provide 'low value' or loss of control of funds for inheritance tax planning. This perceived disincentive to put off saving into a pension no longer exists.
The broader capital markets will also be affected by any decline in annuities. Today, in order to match their long term annuity liabilities, annuity writers are heavy investors in gilts, corporate bonds and infrastructure. If the market for annuities declines, there is likely to be less demand for these types of assets and they will be replaced by shorter duration assets. This clearly has implications for funding of the government and corporates.
To respond successfully we see a number of implications that will vary according to market participant; outlined below.
Annuity writers are likely to see a squeeze on profitability. Currently 75% of people reaching retirement with pension savings purchase an annuity. With annuities no longer being a 'forced purchase', demand will fall, perhaps by more than a third, and pricing is likely to have to be keener. Currently around 50% of annuities purchased by volume have pension pots of less than £20,000 and almost 80% are less than £50,000. Many of those with the smaller pension pots may decide not to annuitise as, given current rates, their pension savings will only give them an annuity income of less than £1,000 a year. They may feel that the certainty of income provided by an annuity is not worthwhile, given the modest income provided and the additional tax payable on withdrawing from the pension fund may not appear significant. The impact on those with larger pension savings is less clear. The majority of the money flowing into annuity sales comes from larger pots, with purchases over £50,000 accounting for almost 60% of total annuity sales by value. Many of these individuals do not have to annuitise today, yet more than half of people who are not obliged to purchase an annuity do so today. They might continue to see annuities as worthwhile, given the guaranteed income levels can be more meaningful to those needing certainty.
Insurance providers can respond to the Budget announcement by expanding their at retirement options. The prize for insurers could be:
- Keeping funds for longer. By developing flexible and simple products, insurers will aim to keep the funds for longer allowing them to earn more fees than on a conventional pension.
- Offering annuity alternatives. Alternative types of annuities or drawdown type products could provide income to customers without the insurer taking on longevity risk.
- Providing asset strategies and guarantees. These solutions would seek to offer a range of alternatives to meet the differing needs of customers in retirement.
We would expect many hybrid product structures to be developed that have some form of guarantees either to income levels or the capital value of the pension pot. Some guarantees will provide total certainty, while others might guarantee minimum values of income or income within a range depending on investment performance. Clearly the annuity market will not disappear. For many retirees an annuity might still be the right product given the certainty of income it provides. In addition, those with health issues might still find the extra income offered by an enhanced or impaired annuity to be attractive. Compulsory annuitisation is not a requirement for a healthy annuity market to exist. In the United States, for example, there is no requirement to annuitise, yet US$220 billion in annuities were written in 2012 and annuities account for 9 per cent of the US$20 trillion US retirement market. These are typically fixed duration annuities and may become a key part of future retirement planning in the UK.
At the same time, providers offering at retirement solutions will need to undertake greater segmentation of customers to understand their different retirement needs at a more granular level. To date, the solutions often have been too generic – over simplifying, e.g. those with pension pots under £100,000 should annuitise, and those with pension pots over £100,000 should go into drawdown. The new, more tailored solution will depend on a broad range of factors, such as the customers’ income need, risk appetite, financial profile, desire to provide an inheritance, etc.
Under the new environment, the winners are likely to be those with innovative product options who can tailor these to the specific circumstances of key customer segments. Insurers must respond proactively, otherwise other wealth managers are likely to step into the space with their own investment products. Annuities provided a significant, certain flow of income to insurers that will now cease, and insurers will need to compete by capitalising on their relative points of competitive advantage, including risk management, product structuring and capital management.
There will still be a large volume of annuity business in force, given that annuities cannot be surrendered. Currently assets backing in-force annuities total over £200 billion, covering previous contracts written. In addition, corporates who have defined benefit obligations will still look to bulk annuities and longevity swaps to cap or eliminate their exposure. The concerns the industry has had in relation to the final details of Solvency II are still very relevant and negotiations around the final form of the Matching Adjustment will still be a major focus.
With more options and flexibility at retirement there will be more need for advice. How this advice will be given is open to consultation, given the Chancellor committed to individuals having the right to free impartial advice at point of retirement. It is well documented that individuals get confused with too much choice, thus they will need guidance or advice to match their retirement needs to the available products. This is not only at point of retirement, but pre and in retirement as well. A rational pensioner should manage their drawdown of pension savings to minimise tax and avoid breaking the lifetime allowance of £1.25 million. Already this advice is provided in the affluent market; however, the Retail Distribution Review has led to an 'advice gap' emerging in the mass market (typically defined as those with investable assets below £50,000). Much discussion has occurred around how to fill this advice gap ranging from workplace, guided architectures, to self-service, which the regulator has been evaluating the implications in various thematic reviews. These deliberations and the result of the announced consultation on free advice will help determine how mass market customers can access advice at retirement. However these customers access advice, they will need simple solutions to their retirement needs, perhaps learning from emerging solutions in the corporate benefits market around target date funds and mutualisation of investment risks across age cohorts.
Investment & Wealth managers
As mentioned above, the Budget changes should encourage savings and provide related asset managers access to investments that previously flowed into annuities. This should be positive for the asset management industry, including insurers with embedded asset management arms. The relative winners are likely to be those who can control both the customer access and the construction of the investment funds. Customers will value those distributors who provide a wide range of investment options suitable to their needs at retirement, which will most often be delivered through platforms. Platforms and other providers of savings accumulation vehicles should be able to hold onto funds longer as they will not be moved into annuities post retirement. However, we have already seen in the platform market, the gatekeepers to these platforms are increasingly influencing which investment managers receive the new money flows and rebalancing of existing holdings. These gatekeepers are structuring managed portfolios for accumulation needs and will likely extend this process to providing managed portfolios for decumulation needs as well. Thus, while the total amount of money being gathered by asset managers as a result of the annuity changes will increase, the flows could be more concentrated. Asset managers will also need to offer a wider choice of outcomes to retirees, providing solutions to income needs rather than just exposure to investment markets.
In summary, the market dislocation caused by the Budget announcement requires a strategic response from annuity writers, pension providers, advisers and investment managers. The annuity market had not been functioning effectively as reflected by consumers’ attitudes to annuities, press criticism and regulatory scrutiny. The changes should create a better functioning market for saving for retirement and opens up new opportunities to those who react and develop innovations that create consumer-oriented solutions.
For more information on the UK Budget 2014, please visit www.ukbudget.com.
Andrew is a Partner in Deloitte's UK Consulting group who focuses in strategy, operational and organisational issues in insurance, wealth and investment management. He has led Deloitte's efforts around RDR and advised clients on numerous policy and commercial matters related to pensions. LinkedIn
Partner, Actuarial and Advanced Analytics
Richard has over 20 years’ experience in the annuity market and has been involved in all aspects of annuity business from distribution to underwriting and asset allocation strategies. He advised on purchase and IPO of Partnership Assurance, the establishment of Paternoster and the re-financing of PIC. LinkedIn