Minister Steve Webb floated the idea at the weekend that pension annuity purchasers should have the option to ‘switch’ their annuity every few years in a similar manner to house-buyers mortgaging for a better deal.

Are annuities good value?
Would switchable annuities be good value?
What about friction costs?
Can we get people interested in regularly reviewing their retirement income?
Will switchable annuities offer fair terms?
Would the switchable option be retrospective?
What can investors do today?
Is the idea of switchable annuities a realistic ambition?

Tom McPhail, Head of Pensions Research ‘The priority should be to get investors shopping around even once at the point of retirement, rather than trying to invent products which either exist already or aren’t likely to be good value for money.’ Annuities are finally getting the public attention they require and with a Westminster Hall debate taking place tomorrow morning, the launch of a new directory of annuity brokers taking place next Monday and the FCA to publish its investigation of annuity pricing sometime in the next few weeks, the interest is unlikely to abate. In the meantime, here are some observations on switchable annuities.

Are annuities good value?
Annuities are good value for money but only if you shop around for the best deal including getting an enhanced rate if you are entitled to one. Unfortunately more than half of pension investors still fail to do this and as a consequence they buy a poor value annuity from an uncompetitive provider; this OMO take-up rate has stagnated in the past few years. The priority should be to make shopping around at the point of retirement the default action for all investors.

Would switchable annuities be good value?
Quite possibly not. In today’s market, a 60 year old buying a lifetime annuity with £100,000 would get £5,474 a year. By comparison, if they bought the same level of income on a 5 year fixed term basis then unless annuity rates improved, at the end of the 5 year term their income would fall to £4,981. This highlights the fact that switchable annuities are unlikely to offer such attractive terms in the first place.

What about friction costs?
The FSCP recently highlighted the fact that advice is not a realistic option for retiring pension investors unless they have at least £25,000 in their pension pot. That’s for a one-off transaction. How much more expensive would the market become if investors were looking to take advice every few years? Introducing switchable annuities has the potential to significantly increase the costs and charges imposed on retiring investors. We do not think this would be a good thing.

Can we get people interested in regularly reviewing their retirement income?
At the moment less than half of pension investors shop around even once at retirement. The primary objective should be to start by getting everyone to shop around the first time round, before trying to make it a regular occurrence. The launch of the PICA retirement broker directory next Monday should help with this process.

Will switchable annuities offer fair terms?
Assuming providers did offer switchable annuities (and they can already today http://www.hmrc.gov.uk/MANUALS/RPSMMANUAL/RPSM09101820.htm, they just choose not to), would they offer competitive terms? They would probably price their transfer values fairly conservatively in order to reduce the risk that customers would switch out as soon as they developed a medical condition. Otherwise they would risk ending up with the healthy (expensive) customers and lose the unhealthy (attractive) customers. Similarly, a sudden increase in interest rates might be offset by a counterbalancing fall in the transfer value.

Would the switchable option be retrospective?
If switchability were introduced, would it be offered to investors who had already purchased a lifetime annuity? This seems unlikely, given the lack of appetite for such an option from insurance companies today. If it were introduced retrospectively, perhaps on a mandatory basis, it is highly unlikely that the terms would be attractive.

What can investors do today?
Fixed term annuities are available today, they just aren’t very popular. By contrast, investors have the choice of lifetime annuities and drawdown plans; these two schemes offer radically different risk profiles and when used in conjunction they can meet most investors’ needs. Hargreaves Lansdown is already seeing a rapid increase in investor interest for drawdown plans.

Is the idea of switchable annuities a realistic ambition?
We cautiously welcome this initiative and will be interested to see whether this is something the Minister intends to develop further. In the meantime the priority should be to encourage investors to shop around when they first reach retirement and to consider all their retirement income needs and product options; this seems a far greater priority than trying to invent solutions which either exist already or are of only marginal consumer value.