The Government has announced that, after eighteen months in consultation and preparation, the planned launch of a secondary annuity market in 2017 is not now going to happen.
The Treasury was right to suggest that the practical barriers to putting appropriate protection in place for the many would outweigh the disappointment of the few.
We consider why the decision was the right one – and also how things might have been very different…
1. There wouldn’t have been much take-up
There was a murmur of approval when, in announcing freedom and choice, George Osborne suggested those who had bought annuity policies should also be able to benefit from the new range of options on offer. But the fact-of-the-matter is, most of those annuitants who wanted to be given the opportunity to cash in their policies would not be in a position to take it up.
Even if priced fairly, sellers of annuities may be surprised to be faced with offers far lower than what they paid for them. In reality, few transactions would actually complete. Add to that the investment and longevity risk that would pass back to them, cashing-in simply would not be in many individuals’ best interests.
The secondary annuity market was also only ever likely to have a very short life-span. A flurry of interest from pre-freedoms annuitants – a small proportion of whom actually going through with the transaction – and then what? Market expectations for sales after this initial period were tiny.
2. Secondary annuity sales were primed to become the next mis-selling scandal…
Reputable IFAs would carefully analyse the balance between an individual’s desire for short-term capital and the need for protected and steady long-term income. In the majority of cases cashing in would not, on balance, be the right thing to do. A recommendation to sell would not be forthcoming.
That wouldn’t stop some individuals, however. Desperate for the cash, they might be tempted to shop around for someone who would be prepared to sign-off on the transaction. And if the price is right, then there might not be a shortage of less-than-reputable organisations for whom the profits would be too tempting.
"Where the demand is coming from an increasingly desperate source, the price they are willing to pay rises as rapidly as that which the provider is willing to charge."
3. …and so broker charges would erode value for annuitants even further (from an already low starting point)
Where the demand is coming from an increasingly desperate source, the price they are willing to pay rises as rapidly as that which the provider is willing to charge. And if the adviser is willing to allow a transaction to proceed that’s not in the customer’s best interests, there’s a good chance they wouldn’t spend too long worrying about whether the customer is getting value for their money.
The market would therefore have been tipped markedly in favour of the buyers, to the detriment of the individuals selling annuities.
4. Capacity constraints and informational inefficiencies would have led to poor outcomes…
So the reality is, even if there wasn’t to be a shortage of individuals willing to cash in their annuity policies, there simply wouldn’t have been as many buyers sitting on the other side of the table and therefore very little competition pushing up the prices being paid on the secondary market.
In addition, the longevity risks associated with pension and insurance arrangements are well-known, well-documented and much more fully understood by the insurance companies and investors who might have formed the very small pool of purchasers, than they would be valued by the annuitants themselves.
All this would have meant the formation of an illiquid market, with limited opportunities to agree sales, where the scales were tipped firmly toward the purchaser.
5. …so annuitants would not have received value for money (although some wouldn’t have cared)
The Treasury was firmly focussed on ensuring that entrants into the market would benefit from suitable protections. Although that might not have extended to ensuring individuals got true value for money, the protections themselves would be difficult to establish and disproportionately expensive. They therefore ended up being the barrier to the market working at all.
Furthermore, the default assumption for insurers acting in this market would be that the individuals selling their annuities were doing so because they were not expecting to live long and healthy lives (regardless of whether this is the reason for selling). The price being paid would therefore reduce accordingly.
The Government would have needed to protect annuitants from themselves...and that doesn’t sit well with the concept of freedom and choice.
6. Should we lament a lost opportunity for pension schemes to hedge mortality risk?
Could the secondary annuity market have taken off...?
A liquid market in annuity policies, leading to pooling by investment companies and insurers could have been a good investment opportunity for pension schemes to hedge longevity risk, by buying into unitised annuity funds.
Even if the profile of the underlying annuitants wasn’t an exact match, a pooled annuity investment could still have been a better hedge for pension scheme liabilities than most other asset classes, and cheaper than buying bulk annuity policies directly.
But without the brokers and insurers in the middle, this is a market that pension schemes are unlikely to be able to access anytime soon.
And so we are left wondering where the Chancellor is going to find the £1 billion of projected additional tax revenue over the next two years, and if we will find out more in November's Autumn Statement...