Secondary annuity market doomed to failure
In its proposed form, the second hand annuity market is in danger of resembling an over-hyped film, where the trailer over promises and the main event under delivers. Star Wars: The Phantom Menace anyone?
One great film does not make a great director and one piece of popular legislation does not make the Chancellor a pension genius. The desire to build on the pension freedoms is understandable but a closer look at the three key components of a secondary annuity market - the seller, the market place and the buyer – and several shades of grey start to appear.
Finding sellers of annuities will be the easiest part. Annuity holders are prisoners of a bygone pensions era, forced into buying a financial product they never really understood and which often represented poor value for money.
Few pension savers will remember how much they paid for their annuity and for a large majority, the take home pension they currently receive will be a paltry amount that does little to affect their standard of living.
Freed of the shackles of compulsion, annuity holders will be queuing up, popcorn in hand, ready to cash in their future pension income for a lump sum.
The market place
The FCA has a well-intentioned desire for there to be an open market in second hand annuities. There are plenty of obstacles to this but the top five as I see them are:
Retail investors - have been banned from investing in second hand annuities, meaning only institutional investors can buy them directly. Whilst I am not advocating allowing retail investors to buy second hand annuities, the absence of these potential buyers makes it less attractive for those developing platforms on which second hand annuities can be sold. As one of the UK’s largest investment platforms, we looked seriously at the opportunity and have discounted it.
Underwriting – will be a critical component in the process for an annuity sale. The buyer wants the annuitant to be in fine fettle and will require evidence, most likely involving a medical. Who will carry out the health MOT and more importantly who will pay for it, particularly if the sale doesn’t proceed?
Advice – requiring a customer to be advised is the easy safety net for the FCA but the truth is, not dissimilar to advising on final salary transfers and with-profit policy encashments, this is high risk work for advisers, where the fee will not justify the effort and risk involved.
Expenses – with the average annuity being sold for between £15k and £20k, the expenses will be disproportionately high. The buyer, the platform, the adviser and the insurance company that holds the annuity will all have expenses to meet and profit to make.
Monitoring death – how will the insurance company holding the annuity know when to stop paying the pension income to the new owner? Talk of a central Government led death register is long overdue.
There are plenty of other issues around accuracy of quotes, treatment of spouse’s benefits and the collection of income tax on lump sum payments but space limits me to a top five here.
With retail investors excluded, there will most likely be two types of institutional buyers.
First is the fund manager who raises money from retail investors to buy second hand annuities within a fund on their behalf, under the guise of what is likely to be regarded as a complex investment. I don’t see much interest from fund managers at this juncture, probably partly because of the scars left by the failed and not too dissimilar second hand endowment market.
Second is the insurance company that holds the annuity, who is without doubt the most obvious and likely buyer of an annuity. This will allow insurance companies to bring forward profits, or losses, on business that would otherwise trickle through on the drip over many years.
The secondary annuity market won’t work unless there is a fundamental rethink of its proposed structure.
The FCA should acknowledge who the likely buyers will be and focus on making sure that these insurance companies do not pocket A Fistful of Dollars from the surrender proceeds.
For example, insurers could be forced to issue annual annuity policy statements, showing the initial purchase price, a summary of benefits received to date, a summary of future benefits and an estimated surrender value. This would help customers to bridge the gap between the original cost of the annuity, the benefits received thus far and the surrender value they might receive.
The Treasury or the FCA could go as far as asking the Appointed Actuary to certify that the surrender value represents fair value for money, a concept familiar to actuaries representing defined benefit pension schemes and those involved in with profit policies.
Unless the FCA learns the lessons of the tainted open market annuity market, the second hand endowment debacle and the pension mis-selling scandal we could find ourselves at some point in the future wishing we could unwind history and go Back to the Future with a very different set of rules.