Despite pension freedom and the recent dip in rates, annuities still provide a source of certainty for three emerging groups of retirees, according to Greg Neilson
The humble annuity goes back a long way. A Norwich Union 1820 proposal states "by purchasing a deferred annuity those who are at present able to procure livelihood, may provide a comfortable support for themselves, when they shall have arrived at an age, at which the ability to labour may be lessened, or exertion become irksome."
Times have moved on, but we believe annuities are just as relevant to customers today. The introduction of pension freedoms in 2015 heralded greater choice and the annuity market saw a steep decline.
Many commentators have talked about the death of the annuity since pension freedoms, but we have seen moderate recovery in annuity sales across the market, particularly over the past year.
Recent Financial Conduct Authorty (FCA) data shows there were 74,000 annuity purchases during 2018/19, roughly in line with sales from previous years. However, this data is combining the growth in the open market with internal annuities.
Association of British Insurers data shows market growth of 6% year on year to Q2 19 for annuities purchased in the open market.
Over the past four years, we have seen the market stabilise and there have been glimmers of a renaissance as IFAs and customers alike see the merits of a secure income.
The average purchase price has almost doubled as we see those with smaller pots exercising pension freedoms and those who have taken advantage of defined benefit transfers seeking a ‘safety first' approach for a proportion of their pot.
Even accounting for the recent drop in annuity rates driven by a sharp fall in gilt yields, we have not seen a drop off in quote volumes or applications.
Peace of mind
This reinforces that even when rates are low, annuities are still a valuable source of retirement income due to the peace of mind that they offer.
Annuities can still look attractive when compared to the sustainable drawdown rates achievable from lower-risk funds of around 3% vs the c. 4% achieved by a typical annuity customer.
Broadly we see two groups of customers currently buying annuities - those who value certainty and simplicity over absolute return and those who are willing to take some risk but want to know their essential spending is always going to be covered.
The first group generally have pension pots of under £100,000, have lower financial confidence, are not willing to take any risk and don't want to worry about ongoing management. They've worked hard all their working lives, followed the rules and are looking forward to a quiet retirement.
They preferred it when the decision was taken out of their hands and so are looking for ways to minimise decision making. They will sacrifice income for certainty and will adjust their retirement expectations to suit. With the changes to state pension age, this group struggle to work out when they can comfortably retire.
For these customers, annuities are the opposite of uncertainty and they welcome the once and done nature of the product. This group make up two-thirds of new annuity customers and they usually come to us directly or through annuity specialists with non-advised sales journeys - while looking for guidance and support, they don't see themselves as the ‘type of person who has a financial adviser.'
More than £200k
The second group usually have pension assets greater than £200,000.
They've had professional careers and see themselves as being defined by what they do. These customers can often take quite a long time to transition into retirement (though it is best not to call it that, as they hate the implication that they will be ‘retiring' from life - quite the opposite, they want to stave off retirement).
They will generally continue to work - whether that be full or part-time - or take the opportunity to change career, start a new business or take time off to travel. Reaching 55 gives these customers choices - and they relish that.
Often these customers have sought advice from a variety of sources (official and unofficial) and they see themselves as being highly financially confident. They may seek advice, but if they don't feel this adds value, equally they may choose to self-serve.
For some of these customers, they want to be sure that their essential spending is covered and so choose an annuity to provide that, with any discretionary spending coming from income drawdown or ad hoc draws. These customers account for around a third of new annuity customers and can come to us direct, through non-advised distributors or via FAs.
These two groups are quite different, not just in terms of wealth and financial confidence, but crucially also in mindset and outlook.
So, in today's market, annuities continue to play an important role - particularly for customers who do not want any investment risk yet want to know they will have an income they can rely on for life.
But there is an emerging third group, who are recognising that whilst drawdown has given them flexibility of income, as they get older, they no longer have the cognitive capacity to want to monitor their investment, or the appetite to weather stock market fluctuations.
They're at a point when they want to lock into greater certainty. We'll come back to that group in a future article ...
Greg Neilson is managing director of retirement at Aviva
Stepping into the pension income unknown
Customers can access whole of market
Blending income options gives better control
'Three eye-catching hares'
Just 3% in passive funds