Annuities still 'fair value' for money

Many lifetime annuities offer fair value for money according to new research by Jonquil Lowe of the True Potential Centre for the Public Understanding of Finance at The Open University Business School.

Related topics:  Retirement
Amy Loddington
25th July 2014
Retirement

The report, which has been published today by the International Longevity Centre UK (ILC-UK) also argues that the protection against longevity risk may be poorly understood by consumers.

Falls in annuity rates over the past 25 years mean that an individual who wanted to start retirement with a nominal income of £10,000 would have needed a pension pot of £65,000 in 1990 but over £175,000 by 2013. This has led to a commonly held view that annuities are a bad investment, which overlooks the insurance value of annuities, particularly in the face of increasing longevity.

The research confirms that the major determinants of annuity rates are life expectancy and long-term interest rates. A simple linear regression of UK level annuity rates for a 65-year-old man against a benchmark 15-year gilt rate and cohort life expectancy using monthly data over the period 1991 to 2013 explains 97 per cent of the variation in the annuity rate.

The research considers whether annuity rates can be considered actuarially fair (i.e. if the expected discounted present value (EDPV) of the income equals the price paid).

Lowe finds that some annuity consumers are getting more than value for money (Money Worth Ratio (MWR) of more than 1). For most people buying the best value annuities (average of the top three rates), the MWR at all ages for women and at ages 55 to 70 for men is greater than 0.85. This is within the usual range for MWR therefore does not suggest an excessive mark-up by providers.
Even the worst annuity rates generally deliver value for money to women, with the exception of those with standard life expectancy aged 75. The worst annuity rates offer poor value for money to men however; the exceptions being men with higher-than-average life expectancy aged 55 or 60.

The results suggest consumer detriment to those male annuity purchasers who end up on the worst rates, but otherwise a product that is generally delivering value for money.

Lowe argues that annuities should be viewed through a consumption frame, focusing on what can be spent throughout the remaining life course, suggesting that if advisers and individuals are using an investment frame, the focus will be on rate of return and investment risk, but not longevity risk.

Author of the report and lecturer in Personal Finance at The Open University, Jonquil Lowe said:

“This much maligned financial product should ideally still play a key role in most people’s retirement planning and in the free, impartial guidance for every retiree promised as part of the government’s pension liberalisation package. A fall in annuity rates associated with increasing life expectancy does not equate to a fall in value for money ; rather it represents a spreading of value over a longer period.”

David Sinclair, Director, International Longevity Centre – UK (ILC-UK) added: 

“The research dispels the argument that consumers should automatically shun annuities on the basis of value for money. But given the gap between the best and worst annuities in terms of value for money, it is vital that we continue to encourage and support retirees to shop around in order to get the best value annuities.”
 

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