research claims increase in value of funds has been enough to offset falling annuity rates
Increases in the value of pension funds over recent decades have offset the negative effects of falling annuity rates, according to research commissioned by the University of Bristol.
Although annuity rates have fallen from a high of 18% in the 1970s to around 4% today, broadly in line with interest rates, the research claims the current generation is no worse off in terms of retirement income than predecessors over the past 50 years, because of the increasing value of pension funds. Over the period under examination, 1956-2002, the average annuity rate for a 65-year-old male has been just over 12%.
According to report authors Edmund Cannon and Ian Tonks from the University of Bristol, part of the explanation for the fall in annuity rates over the past 20 years is that longevity has increased.
'As people live longer, a given sum of money paid for an annuity has to finance a longer stream of income so the amount received per year has had to fall,' the report added.
Despite recent declines in annuity rates, however, Cannon and Tonks believe the product still represents fair value relative to any point in the past 50 years.
Using a measure called the money's worth, the ratio of the expected present value of annuity payments to the money paid for the policy, the report claims that over the period 1957-2002, annuities have been fairly priced on average.
The ratio moves around one with an average of 99p in the pound, with the annuity provider losing money on the transaction if the money's worth moves above one.
'Depending on the assumptions we make about future longevity, the present value of an annuity is around 90%-100% of the purchase price,' the report said.
'Compared with the typical costs of buying financial services, the figure looks suspiciously good. Providers must earn a profit and cover the real resource costs of annuity provision.
'Perhaps even more worrying is the fact that annuity providers appear to have no cushion if longevity rises as fast as more optimistic projections allow.'
The report also looks at patterns in replacement ratios, the relationship between pension income and earnings from work in the last year of employment minus pension contributions, to put current retirement income in some sort of historical context.
If someone puts 10% of their income into a pension scheme and pension income is 60% of earnings from work, the replacement ratio will be 60/90, or two-thirds.
Looking at replacement ratios from various pension fund investments over recent decades, the general trend is upwards in each case, although it is clear the past few years have been a less favourable time to retire than in 1999 when the stock market was at its peak.
Even after the recent falls in the market, however, the current replacement ratio of around four-fifths for pensions invested predominantly in equities is nowhere near as low as in the mid-1970s, when it dropped down to two-fifths.
During the bull market of the 1980s and 1990s, the replacement ratio for equity-invested pension funds averaged just over one, meaning retirement income was equal to that earned in the last year of employment.
According to Cannon and Tonks, it should be noted that the steady growth in replacement ratios since 1980 came despite increases in longevity over the past 20 years. This means an individual retiring in 2002 on the same replacement ratio as someone 20 years earlier is better off, as they should live longer on a similar annual income.
For a copy of the report, visit www.bris.ac.uk/cmpo/wp51.pdf
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