The trouble with annuities...| 57
lifestyle indicators such as
smoking, have been able
increasingly to obtain better
rates through annuities
which are underwritten in
the same way as life
insurance policies. These
offerings are gaining ground
from a slow start and have
the potential to be taken up
by up to 40 per cent of the
market as compared to the
current penetration of 8 per
cent. Such schemes can
often improve on
conventional annuity rates
by 20 per cent or more,
making a very big difference
in retirement income for
those eligible. But if this
trend continues, big
questions are posed for the
continued viability of the
current annuity market.
Also lapping at the UK's
shores are `flexible'
annuities, which have proved
extremely popular in all the
markets in which they
currently operate,
particularly the US. These
products look much more
like an income drawdown
with a guaranteed lifetime
income provided through
use of derivative
instruments, rather than
gilts as in annuities. The
underlying investment fund
potentially provides for
increasing income levels,
assuming satisfactory
growth. It is fair to say that
these products have been
accepted for pension income
purposes, but only up to age
75 so far. Nevertheless, it
seems likely that the lifetime
income guarantee will be
accepted in time and when it
is, it is probable that these
products will displace
mainstream annuities for
larger pots in a market worth
around �14bn per annum and
growing fast.
All this is of material
interest to those with bigger
pension `pots', but according
to the Association of British
Insurers, over 90 per cent of
annuity purchases are for
sums less than �50,000.
These people cannot afford
to take many risks with an
income outcome which will
typically be just around
�3,500 per annum, and it is
certainly arguable that a
conventional or
underwritten annuity is the
route for them. Government
is rightly very keen to ensure
that the `open market
option' � which enables
people to shop around for
the best available annuity, so
as to maximise their
retirement income � is
exercised far more often
than it is now.
LIFETIME IS OF
THE ESSENCE
There is one last `elephant in
the room' to consider, and
that is longevity. As already
indicated, longevity across
the population continues to
improve at a faster rate than
all previous predictions, with
continual advances in
medical science. If the
calculations upon which an
annuity rate is offered are
not realistic then the annuity
will prove to be uneconomic
� irrespective of all the other
threats to the market
identified above � with far-
reaching consequences for
the companies, and pension
schemes, providing them.
If this happens, there
certainly will be trouble
with annuities.

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