Headlines in newspapers about post-code annuities obscure the fact a more general shift is taking place in the market that should allow intermediaries more sope to offer clients useful advice
The once sleepy world of annuities has been shaken up. The advent of greater customer segmentation, refined underwriting techniques and the introduction of impaired life annuities is generating greater opportunities for advisers and providers which is resulting in customers benefiting from better value and wider choice.
The annuity market continues to grow in size (see the graph right). In 2002 annuity business was estimated to be over £7bn and in the first quarter of this year has already grown by 29%. The future business prospects for this market look exceptionally good.
This is mainly due to the favourable demographic position, as there are an increasing number of people due to retire over the next 10 years. As more people retire with proceeds from money purchase arrangements, as opposed to defined benefit schemes, the volume of annuities business will increase dramatically. The potential growth in this market is attracting interest from new entrants, many looking to establish a market niche.
With greater choice available in this new annuity marketplace, increasingly consumers will need to obtain advice when making this key investment decision. Recent analysis by Legal & General revealed that 94 % of people chose to ignore the effects of inflation on their retirement income when buying an annuity and opted for a fixed, level pension. This is very worrying because the effects of inflation on a level pension income, even at today's low levels is still significant.
A person retiring today at 65 will be expected to live, on average, for a further 20 to 25 years. With conventional annuities, the only decision needed was whether to have some form of post-retirement increases or a level annuity. For a majority of people, an annuity still represents their sole source of income other than state benefits. On this basis the choice gravitates to a level annuity, as understandably an individual in this position is reluctant to forego income in the short term for a prospective larger pension in the longer term. This is particularly true where the quality of life in the future is an unknown factor.
The people who currently seek advice and who choose more complicated retirement income options tend to be wealthier customers who have other sources of income. They are able to take a portfolio-based view of their overall level of retirement income and balance short and long term income needs plus consider inheritance tax implications.
There are a number of factors influencing the choice of annuity and a number of proposals in the Pensions Green Paper could also result in major changes to the annuity market in the future. The introduction of protected annuities, limited term annuities and the ability to take small considerations as cash rather than having to buy an annuity, will mean that a different approach in advising annuitants will be required in the future.
The advent of impaired life annuities brought clear benefits for those potential annuitants on modest incomes and in addition, a new group of customers looking for advice. This has widened the market for advisers who can clearly demonstrate the extra value they can deliver by shopping around for their clients. For annuity providers the changing landscape has meant more regular reviews are required on the type and profitability of the annuity business they are writing. Key factors impacting business are investment returns and mortality risk but over recent years activity has been focused on smoker rates, impaired life annuities and more refinement in the underwriting process as companies seek to manage their mortality risk against a backdrop of ever improving mortality.
There have been improvements in life expectancy at age 65, for example over the last 10 years a male can now expect to live to 87 (previously 82). Given this improvement, companies are using factors other than the traditional age and gender in determining the annuity rates they offer. As more companies offer enhanced rates for 'impaired' lives, then the greater the pressure on the remaining providers to avoid selection against them by having a customer profile of mainly 'healthier' lives.
Age and gender will always be the prime considerations in determining annuity rates and the possible introduction of annuity rates based on an individuals post code is just another way of 'fine tuning' the rate offered.
While recent attention has been on possible lifestyle implications for annuities, the real action is likely to be on more objective criteria, such as smoking and medical conditions. This growth in the enhanced annuity market will be in addition to the new annuity proposals outlined in the Green Paper. Details on the actual proposals are expected later this year but are likely to result in even greater choice for the consumer in determining how their retirement income is taken from the proceeds of a maturing pension policy.
Currently it is relatively easy to obtain annuity rate information from providers but as rates become more indicative and enhancements are applied, getting the best rate will need specialist skills, particularly to ensure an annuitant is also making the best annuity provision possible.
While the Retirement Income Reform Bill was timed out in the last session of Parliament, there is pressure to allow annuitants greater freedom with their pension proceeds, yet less than half of maturing pension policyholders take advantage of the Open Market Option. This inertia is very costly. The FSA has been striving to improve awareness of the existence of the Open Market Option and encourage investors to shop around with initiatives such as the FSA online annuity comparison tables. With such activity this once sleepy market is now ripe for further adviser involvement so future annuitants make the most of these various annuity propositions.
How providers can determine pricing
Lifestyle and Occupation
Postcodes are an attempt to classify people by socio-economic group given that there is a correlation between longevity and wealth with lifestyle and occupation. There are several crude ways of quickly assessing this such as last occupation or area lived in. With the former there is considerable data on occupation and mortality risk. Although this information could be used to modify the rate, it would not be the prime driver of the rate applicable.
Smoking curtails life expectancy. The mortality differential between current smokers and non-smokers can be as high as 300%. There are already providers in the market place who will provide enhanced rates for smokers. However, there is a risk for providers in that while it is possible to test whether individuals smoke or not, it is not possible to ascertain how many cigarettes are smoked and so there is a moral risk in this market. Nevertheless, as smoker rates become more prevalent, those offices that do not take this into account will be forced to move to offer rates in this market or they will be left with the healthier non-smokers.
Underwriting on Medical Conditions
The major illnesses that affect longevity are heart attack, stroke, cancer and underwriting on the basis of these criteria is always going to be more objective than on a lifestyle basis. There can be a considerable uplift in the annuity provided where these conditions exist.
Ultimately all annuity applicants may be fully underwritten and the rate based on the results of the underwriting exercise. Given the cost of such measures there is currently a minimum consideration for most of the products in this area, which varies between £20,000 and £50,000. However this is likely to be extended in the future as the market develops.
Source: Legal & General
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