Pensioners currently receiving a poor income from an annuity might be able to sell them for a cash lump sum in future.
A plan to create a second-hand market in annuities is being pushed by Pensions Minister Steve Webb, who is looking to offer an escape route to the estimated five million elderly people locked into these unpopular products.
Some feel that despite being guaranteed an income for life by the products, they would rather take the option of keeping their pension invested and drawing on it as they choose as offered by new pension freedom reforms.
‘I want to see people trusted with their own money wherever possible,’ said Webb in an interview with The Telegraph over the weekend.
He added that annuity holders ‘around the country’ were urging him to make this change, while pension firms and insurers have also expressed ‘considerable interest and enthusiasm’.
Webb is floating his idea ahead of sweeping ‘pension freedom’ reforms this April which will allow people who haven’t already bought an annuity greater powers over their own savings, such as cashing them in entirely or using invest-and-drawdown schemes previously restricted to wealthier people.
As a result, many people who might previously have bought annuities have shunned them and are waiting until after April to take advantage of the new freedoms. But this has left those who bought annuities in the past and are stuck with them feeling frustrated at being shut out.
Workers with final salary pensions are also excluded from the freedom reforms, but have less reason to feel aggrieved since their schemes tend to provide a far more generous guaranteed income than annuities.
Why Are Annuities Unpopular?
Annuities provide a guaranteed income for life but are widely condemned for being bad value, with insurers offering retirees low rates in return for savings pots built up during their working years. People approaching retirement are frequently unaware they can shop around for a better deal rather than stay with their existing providers, and many mistakenly end up buying unsuitable products.
Common complaints are that annuity holders didn’t realise they could get enhanced deals if they were in bad health, or know that if they died first their surviving spouse wouldn’t continue to receive payouts.
Under the present system, once someone has bought an annuity they cannot have second thoughts and get out of the contract later.
But the City regulator recently released a damning report showing many pensioners are left out of pocket because insurers do not explain annuity options properly.
The Financial Conduct Authority is gathering further information before deciding on future action, and it could order firms to offer redress to customers. They would get money upfront to spend, save or invest however they wished, but lose the right to future guaranteed income from an annuity that would no longer be theirs.
The change would involve setting up a second-hand market in annuities operated by pension firms or other companies, as individuals would be unlikely to want or have the expertise to trade such products between themselves.
Once sold to a company, annuities could be ‘bundled up’ and traded on again in bulk. The income would belong to the current owner, but only until the original owner of the annuity died.
How would the Annuity be sold?
The first option would be if an annuity contract was cancelled and the insurer simply gave the investor a lump sum in exchange for it, but this would depend on a fair price being agreed.
This would probably mean the investor having to undergo a medical examination to try to assess their life expectancy. Without this, the insurer could find that all the investors in poor health would try to cash in their annuities and they’d be left with only the healthy long-lived investors (good for the annuity holder but bad for the solvency of the insurer.
Investors tend to underestimate their life-expectancy so would probably over-value an upfront lump sum. Investors also tend to over-value short-term money which could lead them to discount the value of the long term income.
The second option would be for the annuity holder to sell the income stream from it to a third party in exchange for a lump sum, but this would have similar valuation and underwriting issues to those described above.
Purchasers of the second-hand annuities would probably look to buy a portfolio of investments rather than a single transaction to spread risk; this would therefore require the establishment of pooled funds for these contracts. We think this is unlikely to be an attractive commercial undertaking.
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