For a market to work efficiently there must be liquidity – a buyer, a seller and a shop (where items are bought and sold). The idea of annuities being traded requires us to imagine a seller (someone who wants out of a current annuity), a buyer (someone who buys the income stream that continues as long as the buyer does) and an exchange (shop) where an inventory of lives for sale is advertised and the operational issues of transferring claim to the payments is sorted out.
This requires a stretch of the imagination, but in the USA, they are already pretty well there. www.smahub.com is an online shop where “structured annuities” are bought, by people wanting a discounted income stream, and sold, by people who want cash up front (aka jam today). There are others but this lot arrived on my twitter line yesterday and they are the ones I’ve researched.
In America, structured annuities are granted people by insurers settling Personal Injury claims, gambling associations paying lottery wins as an income and other “period certain” grants. Annuities don’t appear (yet) to be traded where the certain end is your certain end (death).
So whatever is going on in America is not personal.
But imagine the system of traded annuities put forward by Steve Webb where you the seller can pass on your income stream to a buyer prepared to take a view on the quality of you! What would sales be dependent on, your good behaviour? Imagine your annuity purchaser lurking outside your front door counting the number of wine bottles in your bins! Your life would be in their hands, you would be living for them.
So whatever happens with lifetime annuities is very personal indeed.
Now let’s think about price. We’ve got used to the idea of an annuity being something you buy at a fixed price which pays a certain stream of payments according to a set of rules (level, fixed increase, first death and second death – you know the rules).
But now let’s think about what your annuity is really worth to someone else. Suppose you bought your annuity when interest rates are depressed (by QE for instance) and subsequently interest rates rose and the cost of buying an annuity fell. Do you think that someone would pay you the same for an annuity they could buy for themselves at 20% less than you paid for it. Wouldn’t they ask for a discount of at least 20%?
In America, the rationale for buying these annuities is that those selling are already prepared to discount, to get their cash today. So those who have bought annuities at the wrong time (while interest rates were low and annuity rates high) will be expected to take a double hit. Reading through the American site it is clear that the intermediaries expect to do a lot of work too- there are lawyers crawling all over the “contact us” section. So you will be paying three times!
Whichever way you approach it, whether from the aspect of selling someone the chances of you living a decent time, you taking a bet on annuity rates or you shouldering the buying and selling cost of the annuity, it is highly unlikely that you are going to do very well out of an illiquid annuity market.
Which is why a pure market solution, as has been proposed by Steve Webb, is not going to happen. There simply isn’t the liquidity, and if there was, the prospect of selling your life to someone else would be a PR disaster and the costs of doing so would make miss-selling accusations inevitable.
In America, there appears to be no market for the trading of lifetime annuities (all that are traded are period certain income streams). In the US the long-tail risk of you living too long is one you bear through your health insurance program (or don’t insure if you are too poor to pay the premiums). Long-tail risk at the poor end of the curve is so acute that you just don’t think about it.
In the UK we have a fudged kind of promise that goes in the other direction, as long as you are poor enough, the State will pick up your long-term care bills. The idea that you could sell your annuity as happens in the States for a cash sum, then blow the cash and fall back on the State, is one that no British Government will entertain.
So unlike the States, if we were to see annuity exchange it would have to be from one form of annuity to another.
I will end by pointing out that there are two retirement income streams that do not work on the principals of insured annuities, the first is the state pension, the second the occupational “scheme” pension. The former could be a counterparty prepared to buy individual annuities (if the Government intended to be a lifeboat- as they are to failing occupational schemes through the PPF). Occupational schemes, or in the broader sense private collective decumulation schemes could become a counterparty if the Government pursued its DA agenda far enough to allow them to provide “annuities uncertain” – e.g. pensions paid under “best endeavour” rules rather than marked to market guarantees.
I’ve mentioned there needing to be three rules for a market to work – perhaps I should add a fourth – there needs to be proper regulation. For any kind of annuity exchange to work in this country, the Government are going to have to relax the fundamental rules binding the state pension not to buy back private pensions or collective schemes not to have to guarantee pensions in return for “transfers in”.
Steve Webb should be careful how he wishes, though what he wishes for- a way out for people who are stuck with current annuities – is devoutly to be hoped for.
Why people like me get cross with him is that he is dangling carrots and waving sticks but the donkey is locked in the stable. To get the animal moving, Steve Webb or his successor is going to have to open the stable door.
Henry Tapper, Founder & editor, Pensions Playpen