Steve Webb’s latest idea that the Government will encourage the sale and purchase of life annuities is not as crazy as it sounds.
Indeed the practice is commonplace in the USA where many court awards are granted as an income for life to the victim. These awards require the purchase of an income for life or a certain number of years payable to the victim. Once the annuity has been granted, the victim sells the annuity back (usually to an insurance company) in what is called a “structured settlement”.
The annuity might have paid out $100,000 over ten years, the insurance company pays out $60,000 day one, the annuity may even be resold on the secondary market at somewhere between the two prices with the purchaser paying for the risk of the annuitant dying earlier than expected.
This kind of financial engineering is unlikely to catch on in the UK. We don’t have the apparatus of brokers and lawyers and insurers and advisers and purchasers and we regard bets taken on other people’s longevity to be a little distasteful, no “death bets please, we’re British”.
But the idea that insurance companies may want to buy-back some of the risk they have assumed (at a discount) is not crazy at all. They wish to buy more risk by setting up bulk annuities to release employers of unwanted liabilities to provide people with an income for ever. Matching these risks by dispensing with existing risk (cheaply) is good news for them and good news for some consumers.
The question is – which consumers….
It is absolutely not good news for someone who lives to 100 to exchange a pension (lifetime annuity) for a cash sum when that cash sum undervalues the pension right.
So the question is one of valuation. Since neither side in such a bargain knows how long the annuitant is going to live, the issue is what is the expected death date assumed by both sides and how big a discount (margin) the insurance company wants.
If a 20% margin is acceptable and the death date is agreed by both side, provided the capital sum paid to the seller is within 80% of the full value of the annuity, no problem.
If the margin is exceeded, the seller may say no thanks and go and talk to the next insurer or say “wtf” and purchase anyway. If we are to have a market , I would expect there to be a degree of bidding between insurers with brokers acting for the sellers.
Of course most of the arguments will be around date of death. Actuarial mortality tables will give the average lifespan and the averages can be refined by taking into account people’s postcode, smoking status and so on. But you’d expect for this market to work properly, that anyone wanting to sell their life expectancy to an insurer would be prepared to undergo a medical. As with life insurance, the insurer will be looking to take a dim view of life expectancy to negotiate the price downwards, the seller will be looking to put on the healthiest of aspects.
Is this ethical?
Many people will find this distasteful, it is a market in death; but it is no more distasteful than life insurance, or the purchase of an individually underwritten annuity.
And for many people, annuities are a regretted purchase. If we could turn back time and get at least 80% (say) of the amount we purchased our pension for, and if we could have that money now, the prospect of a debt-free, holiday filled early retirement have just got a whole lot rosier.
If the majority of our settlement is within our personal allowance, or at least taxed at no more than basic rate tax, the net pay-out may be reasonably efficient and if the outcome of the annuity sale is the avoidance of eviction or similar catastrophe, then a structured settlement looks a Godsend.
Is this practical?
Steve Webb’s plan hinges on the capacity of the market to purchase back annuities at a reasonable rate. Most people who have purchased annuities recently will be hoping to get back something like the purchase price less the income already received.
This assumes that the annuities were fairly priced in the first place.
There are undoubtedly some annuities which were sold in the past ten years at the wrong price. Typically where a super-healthy person bought into a pool that assumed short life spans and where the insurance company’s margin was high.
But many people will find that what they bought was at fair value. There issue is not that they bought badly, but that they never wanted to pay the price they did for the guarantee.
For both groups of people, it may be better that they start agains and scrap Plan Annuity (even at a heavy cost relative to the original purchase price)
If there are sufficient insurers (and reinsurers and banks) out there, and if the US infrastructure of advisers, lawyers and brokers can be established at a reasonable cost, then – YES – this is practical.
But this is a big “if”- the political bit!
I think it unlikely that the market will form quickly unless it is given a leg up by Government.
We will see a new Government in a few months, the promises made by a Pension Minister seeking not just a second ministerial term, but fighting for his parliamentary seat, may not seem as strong as one made by a new Minister in May 2015.
Whether Steve Webb’s intention is simply to steal a bit of the Treasury’s pie or whether it is a genuine promise that will receive cross-party support remains to be seen. If the latter, I give the idea my support. I don’t think that those who were forced into annuities (not by law but by the market) over the past 10 years have had fair treatment.
Should it get our support?
I don’t think they should have redress through mis-selling, the process was imperfect but not deceptive (unless there is clear evidence that the customer was not treated fairly).
As Michelle Cracknell made clear in her radio interview with Steve Webb, no-one should be selling their pension without knowing what they are doing. This process needs to be properly regulated and there needs to be advice on hand.
But with these caveats, I see no reason why structured settlements shouldn’t be offered to those with unwanted annuities and while I don’t see the resale of these annuities to the retail market anytime soon, I think they can create capacity for insurers , reinsurers and banks to get on with the issue of longevity swaps that are so needed by our large defined benefit plans, creaking under the weight of their guarantees.