HM Treasury confirmed that they are pressing ahead with reforms that will give more than 5m pensioners new flexibility to trade their unwanted annuities for cash. Under the plans, a ‘secondary annuity market’ will be created allowing pensioners to trade their income on the open market.
Seen as an extension of the landmark pension freedoms reforms, the secondary market is estimated to bring in nearly £1bn in tax take in its first two years. For a Government battling with a deficit – you can see the attraction.
At one level it’s a relatively straightforward proposal. An annuity provides a known amount of income so we can assign a value to this income stream. This gives the opportunity to re-visit past decisions in the light of new options and information. The problems are around costs and value.
The cost of running an annuity is spread over the lifetime of the payments by the insurer; these costs included distribution, commission, underwriting, investment and profit. It would be incredibly naive to think that the outstanding costs and profits will not be deducted from the ‘value’ by the insurer.
Valuing annuities for resale is very difficult. Effectively you are buying a bond with a known coupon, zero redemption and a term that is pretty much unknown. The first two parts are straightforward, but how do you make a fair – unbiased – assessment of life expectancy at an individual level? The skill set for this assessment is expensive and a combination of actuarial analysis and medical assessment. It would be difficult to find a doctor that would certify a healthy person’s life expectancy and the ‘data’ available to actuaries is based on populations. So it is likely that insurance underwriters will be involved, but wouldn’t they be acting in the best interests of the insurer? I doubt that individuals would be prepared to pay for an ‘independent’ underwriting process from a third party.
My biggest concern is either that ‘fair value’ will not be fair, or the cost of getting there will be huge. When you take costs into account, the amount of money received by the consumer will be significantly less.
To protect consumers the government is proposing a similar mechanism to transfers from Final Salary Pension Schemes. If the surrender value exceeds a certain amount then financial advice must be sought. This assumes a market of advisers who are:
- qualified to give this [the qualification itself hasn’t been designed yet] and
- are prepared to advise in this area.
There will always be advisers who are prepared to take on more qualifications; this is a good thing provided the motivation is to benefit their clients. However, given the difficulties in ascertaining ‘value’ I would expect many advisers to choose not to operate in this area. The threat of future complaints and an inevitable regulatory review make it an unattractive proposition. There will also be advisers who recall recent scandals around Traded Life Policies/Life Settlement Funds and this will have an impact on their decision making process.
I question who will be providing this advice? Pension Wise will be covering this area, but it will only be guidance and financial advice will still be needed. I’m worried that this will leave a small number of advisers who are perhaps motivated more by the fees they can charge than the best outcomes for their clients.
Undoubtedly, keeping an annuity will be the right decision for the vast majority but those that do want to take advantage must be protected. This initiative is a great example of an idea that has good principles and intentions, but hasn’t actually been thought through properly. We must avoid this becoming another mis-selling scandal that taints the industry, yet again.