Performance of pension funds most important factor going forward
The key to the size of annuity received going forward is the performance of pension funds rather than the movement of bond rates, according to Billy Burrows, managing director of William Burrows Annuities.
Burrows pointed out that although annuity rates fell for most of the 1990s, the capital value of annuities was increasing faster than rates were falling because the stock market was doing so well.
In the past two years, however, annuity rates have continued to fall alongside declining interest rates and have been dampened by the decline in equity markets, he said. As such, Burrows feels the key for annuities going forward is how pension funds perform.
Burrows said annuities are calculated on three factors: prevailing gilt yields, life expectancy and expenses. If gilt yields do not move, annuity rates will fall because people are living longer, he added.
Burrows said 60-year-olds, with a life expectancy of another 20 years, should look at going into with-profit annuities on a long-term view.
Over the past 12 months, annuity rates have fallen 10%-15%, with the major factor for this being the reduction in gilt yields and an increase in life expectancies, according to David Marlow, head of marketing at the Annuity Bureau.
As at 7 April 2003, the 15-year notional gilt yield stood at 4.65%. Marlow said the yield has fallen because of the incredible demand for the asset class from institutional investors, leading to hikes in the price.
While Marlow feels the increased demand for gilts has been good for the unit price on gilt funds, he believes it will work against them when it comes to buying an annuity because this increase in demand is suppressing annuity rates. Marlow added: 'The biggest factor for annuity rates going forward is the underlying performance of the 15-year notional gilt yield. If this yield rises, so will annuity rates.'
While Marlow expects a gradual improvement in annuities, as he believes demand for gilts will fall as the Government increases its borrowing, he said the life expectancy trend remains a permanent factor in suppressing rates.
Both Burrows and Marlow pick up the same groups as offering, at present, the most competitive annuity rates. These include Canada Life, Norwich Union, Legal & General and the Prudential.
On a £100,000 spouse's pension, a 60-year old male would get a £5,635 annuity from Canada Life, while from Axa the same annuity would be £5,452.
Compared to gilt yields, the yield on 15-year corporate bonds, on A plus credit, is typically 100 basis points over gilt yields.
Corporate bonds have become increasingly popular among annuity providers because of the increased yield they can offer. For example BT, which is BBB-rated, currently offers 150bp over gilts, while GKN, another BBB bond, offers 225bp over gilts, on 15-year duration paper.
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