By Matthew Oakley
Following its call for evidence earlier in 2015, the Government recently committed to facilitating the creation of a secondary annuity market. I’ve always thought this is a risky thing to do and, if this market does not work well in 2017, the Government needs to consider more radical options.
How the Government got to this decision is reasonably clear. Prior to April this year, most of those with defined contribution pensions were required to purchase an annuity on retirement. However, sweeping reforms announced over the last couple of years have meant that new retirees do not have to do so. By facilitating the creation of a secondary annuity market, the Government’s intention is to open up these freedoms to some five million retirees who retired before April 2015 and purchased an annuity.
First it is important to say that the Government was right to introduce radical reforms for new retirees. For many people it makes little sense to buy a guaranteed income at 65 when they could see significant capital growth in their pension pot, drawdown what they need and purchase an annuity later in life (at say 75 or 80). The approach has also proven extremely popular with the public. So, with the background of a general perception that many people retiring prior to 2015 might have been better off if they had been afforded those freedoms too, it is unsurprising that the Government turned its attention to the potential for a secondary annuity market.
However, while in principle the idea is attractive, there are real risks associated with taking it forward in practice. Most obviously, given previous experience in this market, there are real concerns about mis-selling and the FCA will have a vital role in policing the market when it is up and running.
However, aside from mis-selling, the main problem is likely to be value for money. To provide good value for annuity holders looking to sell their income stream, the market will have to develop quickly. Amongst a range of other things, the new market will need a large number of sellers, so that risk for buyers can be effectively pooled. It is also clear that, in order for effective competition to drive the market, consumers will also need to be active, engaged and well informed.
However, for each of these, there could be real problems:
- As the Government outlined in the consultation response, the best option for the majority of annuity holders is likely to be to hold on to their guaranteed income. This significantly limits the potential scale of this market; and
- Past experience of the retirement income market shows us that, even when making this vital decision, the majority of consumers are not active or engaged and are certainly not well-informed. For evidence of this, we only need to look at the high proportion of consumers choosing not to shop around annuity providers or not purchasing an enhanced annuity when they would receive significantly higher value from doing so.
Consumer expectations of this market are also extremely optimistic. Evidence from Which? shows that nearly two-thirds of those considering selling would expect to receive 90% of their pot back. However, estimates from Fidelity suggest a figure between 53% and 63% for a 75 year old who had bought a £100,000 annuity ten years ago.
Overall this suggests that the number of sellers might be relatively limited. Those that choose to sell are therefore likely to be those most in need, who have no other options. Perhaps because they need cash quickly to deal with a medical problem or to pay down debt, but whatever the reason, they may be unlikely to receive a deal that provides them value for money and that makes sense for them in the long-term.
The frustrating thing is that the Government was right to highlight the need for action in this area. Those previously pushed into annuity purchases that did not meet their needs by mis-placed Government policy should now have options to improve their situation. But trying to tackle the past failures of Government policy making through a market solution, is not always the right approach.
Instead, Government should have bitten the bullet and provided a guaranteed value option for those it thought were entitled. Perhaps allowing a small proportion of those buying relatively low rate annuities over the last ten years to sell their annuity to a state-backed provider like NS&I. This would have tackled the problem, whilst providing value for money and ensuring that consumers were adequately protected from a market that could leave them considerably worse off in retirement. If the market does not go well in 2017, this is still an option open to Government.