Sizing up the secondary annuity market opportunity
12 September 2016
Comment from Adrian Boulding, Head of Retirement Strategy at Dunstan Thomas
On the 6th April 2017, the Secondary Annuity Market will be declared open for business. The ground was laid with the publication last April of the FCA's Consultation Paper 16/12 'Secondary Annuity Market, proposed rules and guidance'; HMRC's 'Creating a secondary annuity market: tax framework'; both following the DWP and HM Treasury (HMT) 'Creating a Secondary Annuity Market - Response to call for evidence consultation', published last December.
We now know that the existing annuity market is made up of 6m policies, being paid out to some 5m people. The market is worth an average of 13.3bn each year. HMT predicts that 300,000 will be tempted to cash in their annuity pots. The FCA puts its own estimate of market size in the first three years somewhere between 102,500 and 305,000. However, an adviser firm Portal Financial's survey, conducted last March, found over half of 1,000 consumers queried (569) would consider selling their annuity.
The main reason for doing so (noted by half of respondents) was if the retirement income it promised is too small to make a noticeable difference to their lifestyle. A further quarter (22%) would cash it in to make a significant purchase. The human preference for immediate over deferred consumption is clearly seen here - if I can live without the income I could spend the capital on something nice today!
The market for in force annuities is worth looking at in more detail to estimate how big this market might be if over 50% of us are potentially in the market to cash in our pensions and those with smaller pots are most likely to do so.
For this the Association of British Insurers (ABI) has good statistics which show average annuity size purchased in just one recent year - 2013 - was 35,600. In that same year median value was 20,000 which means that half of all 353,000 annuities sold in this year alone were worth less than 20,000. That means that even the most generous annuities quotes will offer half of this group below 70 per month retirement income, not much more than a tank of fuel and less than many people's weekly grocery shop. So on those figures there could be 176,500 (50% of 2013's tranche of annuitants), annuity holders in the market to cash in their pension? If this is the case, then even HMT's numbers start to look pessimistic.
More in line with these numbers is another survey conducted for Old Mutual by YouGov which reckoned 17 per cent of annuitants may be in the market to cash in - that is 850,000 in total.
The fact that HMRC has admitted Defined Benefit (DB) schemes into the secondary annuity market strengthens the market opportunity still more. Those members who have had their benefits secured by annuities are eligible, provided the trustees have, or are willing to, assign the annuity over to them. It's worth noting that many DB annuities are really quite small. Because of this, the issuing life office will be keen to buy them back in order to close off the administrative costs of low monthly payments.
Pinsent Masons partner Simon Laight said putting final salary into the secondary annuity market is significant and could increase appetite for the buyout market: "If insurers assume that a proportion of the liability they are taking on can be offloaded relatively cheaply, perhaps the buyout can be priced more keenly, leading to greater deal flow."
Moves by the likes of Rothesay Life to purchase in force annuity books of the likes of Zurich and AEGON in recent months, suggests there is going to be strong demand for in force annuities ahead of the market opening in 7 months' time.
Indeed, rising gilt prices linked to all but very recently purchased annuities, means that valuations are likely to be very encouraging for the next 2-3 years at least which should stimulate demand still further. The 7th July auction of UK government gilts drew orders equal to 2.33 times the amount sold, making it the most in-demand sale of conventional UK government securities since 2010. This latest auction is Britain's second issue of debt since voters decided to leave the EU. The first - a sale of 2021 debt- sold at a record low yield of 0.38 per cent because demand for our debt is currently so high. Pensioners will at last have a reason to thank Bank of England Governor, Mark Carney.
Quite apart from positive valuations, there is some logic in cashing in smaller pots because these pay-outs offer people an opportunity to do something meaningful with a lump sum, perhaps buying a new car; clearing down an outstanding loan which is exposed to high interest rate payments; or helping a child or grandchild with a deposit for their first home.
It is also possible that others will aim to reinvest the lump sum in a more flexible retirement savings product like a new flexible annuity or Flexi-Access Drawdown policy. Some will want to cash it in to improve the inheritability and provide for dependants and spouses. Many might want to turn legacy single life to new joint life policies.
There have been several reports that DB schemes may become major investors in secondary annuities although they cannot underwrite the schemes themselves so they would look to insurers or life assurers to do so. Aviva is reportedly eyeing up this particular market opportunity. DB schemes may also elect to buy annuity funds likely to be put together by investment managers. So the secondary annuity market will spawn a tertiary annuity market!
HMT may well be pleased if the market does better than expected. Its current predictions put receipts at 485m in Year 1 (2017/18) and 475m in Year 2 of annuities trading.
The latest on putting in safeguards to prevent people ending up worse off as a result of cashing out, is to give all annuitants planning to sell access to Pension Wise service for free. Those with larger sums in annuities will need to seek regulated financial advice.
The level at which financial advice will be mandatory will be set by HMT this autumn after a consultation, but there is some speculation that it may be set at an annual income level of 5,000, which suggests a pretty chunky total sale value, well north of the 30,000 cash equivalent total transfer value threshold set for DB to DC transfers requiring advice.
The only other question is how many financial advisers can be persuaded to give advice which leads to cashing in an annuity? However, with the potential scale of the market, strong pricing, market participation and ideally online quotation tools in place pre-April 2017, it seems likely that enough retirement advice specialists will be happy to extend the scope of their advice to this final frontier of 'pensions freedom and choice'.
Adrian Boulding is Director of Retirement Strategy at Dunstan Thomas