Not Challenging the Industry
"Securing a Retirement Income"
by Stephen Wynn

1. "Are lifetime annuities the best way to provide a guaranteed lifetime income for our members?"

This was the first question in the discussion paper of the PADA Securing a retirement income. ^x The answers in the affirmative in Appendix 1 below are handing over the provision of pensions to the insurance industry, which likes annuities because they are good business. This is not challenging the industry.

The best way to secure an income from capital in retirement is to receive investment income, together with some capital gains depending on the type of investment. For example, smaller oil companies usually do not pay dividends. Lifetime annuities are not the best way to secure an income in retirement. Annuities have various disadvantages listed in Appendix 2.

This is "provide a low-cost inome drawdown facility", in "What you told us in response" in A summary of responses following public consultation: ^x

The trustee could provide a low-cost income drawdown facility for members below age 75 and permit them to take income from their funds rather than annuitise.

There is no reference in the discussion paper to "income drawdown facility", only to "income drawdown product", for which funds have to be "transferred out":

If a member wants to take out an income drawdown product, they will be able to do this by transferring their funds out of their personal account to another registered pension scheme.

Do members actually want or need a guaranteed lifetime income from an annuity? They probably already have an income which may be more than adequate. When people retire they have more time to look after their investments. This requires capital rather than income.

2. Quantitative easing

Annuity rates have been dropping.

Pensioners get just HALF the annuity rate of 15 years ago ^x

Ros Altmann says that this fall in annuity rates has largely been caused by quantitative easing.

Pension funds are being damaged hugely by the crisis as quantitative easing has artificially depressed long yields, which inflates liabilities. This is storing up inflation problems for the future too. ..

The biggest scandal relates, in my view, to people retiring now who have seen the value of their pension funds plummet and now find that quantitative easing is forcing annuity rates against them.

They end up with less pension for life and could be buying at a terrible time. The government forces people to buy an annuity, then forces the price against them. This cannot be right, but people don't get advice, don't understand annuities and end up stuck with the wrong product, bought at the wrong time, for the rest of their life. A 65 year old retiring today would get over 30% less pension that his friend who retired last year, just because of the movements in markets and annuity rates." ^x

3. Compulsory annuitisation

If annuities are the best way why to obtain a retirement income, why do they need to be compulsory? The Xafinity paymaster evidence says:

Within the current statutory environment they are the only way to provide a guaranteed lifetime income for members.

At present in the United Kingdom, retirees in DC schemes wishing to turn a pension saving pot into actual pension income are generally faced with two broad choices: buy an annuity at the current market rate (with 75%-100% of their pension savings) or defer this purchase until, at the latest, the retiree is 75 years old. While it is technically possible to avoid the purchase of an annuity by using the Alternative Secured Pension (ASP), tax disincentives make this route problematic. Indeed, the Government has noted that this is not a “mainstream product” and would not allow it to be used “to get round the annuity rules”. For its part, the FSA commented that ASPs were “only intended for a small group of people who have a principled religious objection to buying an annuity”. ^x

This paper points out that annuities are not compulsory in Australia, Canada or the United States. Are they compulsory anywhere outside the UK? The question: "Are lifetime annuities the best way to provide a guaranteed lifetime income for our members?" is saying members will be provided with a guaranteed lifetime inome whether they want or need it or not. Therefore the "yes" responses in Appendix 1 imply the respondents agree with compulsory annuitisation, although:

Pensioners are boxed into a corner and forced to purchase an annuity on reaching 75 for many this is a poor investment. The case against compulsory annuitisation is overwhelming. ^x

4. Comments of the respondents

Inflation

Fourteen out of 46 responses mentioned "inflation".

Default annuities/small sums

The IMA says:

Given the complex choices and the likely existence of many very small pots, particularly in the early years, having some form of default option for decumulation is likely to be desirable.

The enrolment and accumulation phase of Personal Accounts is largely predicated on inertia. .. With the majority of auto-enrolled individuals expected to be ‘double defaulters’ – ie. both auto-enrolled and expressing no fund choice, an immediate challenge for both PADA and the wider DC market will be how the default option for the accumulation phase is designed. .. The report implicitly suggests that there may be at least two reasons why a default should not be offered: concern about competition issues (Para 4.1) and about the line between support and advice (Para 4.3).

We believe that the question of default options should have been included in the consultation in order to have a clear debate about the difficult issues involved in the exercise and structure of choice.

Money's worth

No responses seem to have questioned the validity of the money's worth values for annuities, which I do in my own response.

Appendix 1

Responses to:
"Are lifetime annuities the best way to provide a guaranteed lifetime income for our members?"

ABI: Yes. It is likely that members’ income from Personal Accounts will be their only retirement income, other than state retirement benefits.

ACA: We agree that, based on current available products, lifetime annuities are the best way to provide a ‘guaranteed lifetime income’ for the vast majority of prospective PA members.

AEGON: AEGON UK agrees with PADA that a lifetime annuity is the most appropriate method of securing a guaranteed income for the vast majority of personal accounts members.

Age Concern and Help the Aged: We agree that lifetime annuities are currently likely to be the most suitable option for most members, and the ability to transfer funds out to another provider will be a valuable alternative for those for whom other options, such as income drawdown or an unsecured pension, are more suitable.

APL: As the number of individuals with DC accounts grows,we can expect to see increased variation in the sorts of pensions and especially drawdown products on offer through the open market option.However, for majority of personal accounts scheme members lifetime annuities will be the only option unless annuitisation from the scheme itself is available.

AXA: Given that the option to transfer out or access the open market exists there is no impediment to consolidating benefits into an alternative vehicle if a member requires this.

BGI: Annuities are a very effective way to provide lifetime income for participants in a defined contribution scheme.

British Chambers of Commerce: (no opinion)

Buck Consultants: For the typical target personal account scheme member, we undoubtedly accept that the provision of a lifetime annuity is the best way to provide a guaranteed lifetime income.

Canada Life: In the early years of the Personal Accounts scheme, the pension pots will be small and therefore we agree that a lifetime annuity will be the most suitable retirement product for the majority of scheme members.

Capita Hartshead: We agree that the lifetime annuity is the best product to secure a guaranteed income for life.

Friends Provident: Yes.

FS Consumer Panel: Annuities are the only way to provide a guaranteed lifetime income for members;

Hargreaves Lansdowne:We are passionate supporters of retiring investors maximising the value of their pension savings when they convert them into an annuity.

HBOS: Yes. We believe that lifetime annuities are the way forward for PAs.

Hewitt bacon and Woodrow: Yes.Any other option creates additional layers of choice that will be almost impossible for the majority of our members to compare and decide between.

HSBC: In terms of the current market for retirement products, our answer to that question is “Yes”. However, we think that, arguably, it may be the wrong question.

ICAEW: Yes. As referred to above, a simple annuity default option should provide the most appropriate mechanism.

IFDS :We agree that a lifetime annuity delivers a guaranteed level of income to a person in retirement.

ILAG: Yes, as scheme pensions will not be available

IMA: (no opinion)

Institute of Directors: Our experience is that the more people “understand” about annuities, the less they like them.

Just Retirement: We believe Lifetime Annuities offer the best combination of return, security and clarity for the likely size of funds that will emerge from Personal Accounts in the foreseeable future.

Legal and General: The primary financial need of Personal Accounts members will be for a stable, predictable income that will last for as long as they do. This is what a lifetime annuity provides

Mercer: We agree that lifetime annuities are the best way to provide a guaranteed lifetime income for most members of the personal accounts scheme, subject to developing an appropriate solution for small funds.

MGM Advantage: On the assumption the maturing pension values will be relatively small (i.e. less than £50k), then we believe this is a sensible conclusion, as the other retirement income options are not guaranteed and present risk for the consumer.

NAPF: Yes. The NAPF believes that the degree of certainty and income protection provided through annuity purchase means it will be the best option for the vast majority of Personal Accounts scheme members.

Northern Trust: (no opinion)

Norwich Union: Norwich Union agrees annuities are the best way of providing a guaranteed lifetime income, particularly for the target market of Personal Accounts.

Origo: (no opinion)

PMI: Yes.Annuities are simple products that meet the needs of your expected members.

PPI: Given the nature of the target market, the overall approach to securing an income in retirement seems to be reasonable and appropriate

Prudential: Yes. Lifetime annuities are the best way to provide a retirement income to most members of the Personal Accounts Scheme.

Scottish Widows: For a large majority of members a lifetime annuity bought at a single point will be the right method of providing retirement income.

SPC: Since fund sizes, in particular in the early years of personal accounts, will probably generally be small, we agree that lifetime annuities will be the best way to provide a guaranteed lifetime income.

Standart Life: Lifetime annuities give people a clear position on how much money they have to live on each year.

The Equality and Human Rights Commission: We support the general intent of the structured processes proposed to enable individuals to choose the correct annuity for their circumstances, and to maximise the income from their annuity choice through a two phase annuity purchase process: • Choosing the type of annuity • Choosing the annuity provider

Stephen Wynn: The discussion paper on securing an income in retirement seems intended to help the industry sell annuities.

TISA:We agree that annuities will be the right choice for the vast majority of retiring members, and that for most, there will be no need for advice.

TPAS: Yes; for the reasons put forward in the consultation paper.

TUC: We agree that lifetime annuities are the best way to provide a guaranteed lifetime income for the vast majority of personal account holders, but have no objection to allowing scheme members to transfer their savings out to access other types of pension income.

UKSA: Assuming that the intention is to provide an income for life, we do not see that there is a realistic alternative for most people to lifetime annuities. However, there are two key issues: (a) type of annuity, and (b) market availability and capacity.

Which: We agree that, given the existing regulatory, tax and legal rules, lifetime annuities are the best way to provide a guaranteed lifetime income for personal accounts members.

Xafinity Paymaster: Within the current statutory environment they are the only way to provide a guaranteed lifetime income for members.

Appendix 2
Disadvantages of compulsory annuities for the public

1) They are a gamble on: a) annuity rates when you retire, b) the value of pension savings when you retire, c) the future rate of inflation.

2) They are based on bonds, which have no capital growth and lower yield than shares, because there is no longer a reverse yield gap:

The 4.8 per cent paid on the UK share indices is about a percentage point above the yield on long-term government bonds. ^{x x}

3) They are dissaving rather than saving.

4) They are irrevocable.

5) They have opaque charges and money's worth calculations.

6) People may not need an additional regular income. They may prefer to receive cash, or reinvest investment income.

7) They destroy capital.

8) Trying to choose the best annuity is a nightmare, hunting through websites, obtaining quotations, delays. ^x

9) Annuity rates are falling. ^x