Is the secondary annuity market a step too far for pension freedoms or something that will benefit pensioners? As with all of these big questions, the answer is probably somewhere in the middle, says William Burrows Annuities founder Billy Burrows
As the clock ticks down to April 2017, when those who purchased annuities before the new pension freedoms will be able to exchange their annuity income for a cash sum, feelings in the industry are mixed.
Perhaps the biggest concern is that the market is simply not ready for such a radical new policy on top of all the other changes to pensions in the past few years. It would appear that annuitants are ready to sell their annuities but financial institutions who will buy the annuities, and brokers and advisers who will intermediate, are far from ready.
The basic workings of the secondary annuity market appear relatively straightforward. Those selling annuities will be able to do so in one of two ways: by selling their annuity back to the original annuity provider or by selling it on the open market.
In theory, they will have the choice of a cash sum, which will be taxed at their marginal rate, or to have money transferred to a flex-access drawdown. If the annuity is above a certain amount, which has yet to be disclosed, regulated financial advice will be required. However, the devil is in the detail.
There is little data on the size of the potential market but official estimates suggest that between 100,000 and 300,00 people will sell their annuities, with the vast majority selling in the first year. There is little information about the size of individual annuity sales.
I envisage three types of customer, one of which is those with relatively small annuities who don’t place a high value on the small amount of income they receive and consequently would rather have a lump sum. These customers may not be very price sensitive because their primary objective is to get a cash sum.
At the other end of the scale may be a small number of higher net worth individuals who have annuity income which is not necessarily required and is taxed at the higher rate. There may be a case for trading this annuity income for money in a flexi-access drawdown, which can be used for tax or inheritance planning.
In between, there are those in receipt of annuity income on which they rely to help maintain their standard of living. It is this ‘middle market’ group that have the most to lose if they give up valuable income only to spend the cash on luxuries.
Will sellers get value for money? Some experts suggest they will only get about 70 per cent of the cost of buying the same income on the market today. So if someone purchased an annuity three years ago for £ 50,000 when they were aged 60, they would have received £ 2,500 per annum gross income. Today, this income stream is likely to sell for about £ 35,000 – a discount of about 30 per cent on today’s market value.
To have a proper market, there needs to be enough willing buyers. As it stands, the FCA has only identified 10 buyers, of which seven would be annuity providers only buying back their own annuities, and three open market buyers.
One possible outcome is that the secondary market becomes primarily a buyback market. If there are only a few companies offering to assign annuity incomes in return for cash on the open market, this suggests a lack of competition and frustration for customers if their original annuity provider will not buy back.
Finally, spare a thought for intermediaries. The FCA distinguishes between brokers and advisers. Brokers can arrange annuity buybacks without giving advice – providing it is below the advice threshold – but they cannot take commission. Advisers have already said it will be difficult to give advice because most people will probably be offered less for their annuities than will be needed to justify good advice. Advisers are also worried about insistent clients in the same way they are for DB transfers.
The secondary annuity market turns everything we know about annuities upside down. When annuities are sold originally, people are told to disclose all their medical conditions, but when they sell them, they will get the best price if they are healthy with the prospect of a long life expectancy.
Unless there is a competitive open market, it could turn into a market of buybacks where customers will not know whether they have got a good deal or not.