Shop around and you could smoke out a better deal for retirement

JEFF SALWAY

CONVENTIONAL annuities are the automatic choice at retirement for the vast majority of people but with rates set to continue tumbling more people are looking for other ways of securing their retirement income.

The income available from annuities has fallen further this month and rates are down significantly from 2009, according to the latest figures from the Alexander Forbes Annuity Bureau. The best annual income available for a 60-year old male with a 100,000 pension pot is now just 6,180, compared with 6,440 in April last year.

And they are likely to fall further, with several providers pulling back in advance of EU legislation coming into force in 2012 that is expected to have a huge impact on annuity rates.

Annuities are largely backed by corporate bonds, but under the EU’s Solvency II rules insurers will have to hold additional capital reserves to match their investment risk. Consequently annuity providers are likely to reduce exposure to corporate bonds in favour of gilts, reducing the funds with which they can pay out on annuities.

Axa cited Solvency II as the reason for its withdrawal from the enhanced annuity market, while the rules are the major factor in Aegon’s annuity rates becoming markedly less competitive in recent months.

Vince Smith-Hughes, head of retirement income at Prudential, said: “It looks certain that we’ll see a drop in annuity rates. At the moment providers back annuities with corporate bonds and if they have to hold more capital to do that they might go to more gilts, where the yields are not so good,” he explained.

Smith-Hughes confirmed that Prudential was among those pricing Solvency II into its annuities. “If you look solely at Solvency II you can safely say that annuity rates have further to fall.”

Nigel Callaghan, pensions analyst at Hargreaves Lansdown, said the impact of the legislation on annuity rates could be as much as 20 per cent.

“It is a huge piece of legislation that is already impacting annuity rates and will knock them sideways when it comes into force.”

As a result retirees will increasingly seek other ways of securing their retirement income, such as asset-backed and inflation-linked annuities and income drawdown.

Asset-backed annuities offer a minimum guaranteed income level and the chance to get a higher income than from a conventional annuity. These are available primarily in the form of with-profits and unit-linked annuities which provide exposure to both the risk and growth potential of the markets.

Asset-backed annuities are increasingly used as one part of the annuity purchase, with people investing some of their pension in a level annuity for maximum growth, part in an inflation-linked annuity and the rest in an asset-backed annuity, providing a combination of security, inflation protection and growth potential.

“We are starting to see more interest in asset-backed annuities, and it does move in line with annuity rates because falling rates make asset-backed annuities look more attractive.”

For the healthy and wealthy the income available from annuities will also be driven down by the increasingly sophisticated pricing models used by insurers, most notably postcode and individual pricing. This means the healthiest and the wealthiest will be offered the lowest annuity rates as insurers assume a longer period of payouts.

“The ever-increasing rise of enhanced annuities is cannibalising the general annuity pool, meaning that those remaining, or those who don’t shop around, are increasingly assumed to be healthy and long-living,” said Callaghan.

So the onus is on retirees facing deteriorating annuity rates to take matters into their own hands by getting the best retirement income available. This can be done through the open market option (OMO), under which retirees have the option of searching the market for the best deal rather than settling immediately for the rate offered by their insurer.

Calls are growing for the OMO to be made the default option instead of merely being mentioned as an alternative in the literature sent to workers ahead of retirement. Just a third of retirees exercise their right to shop around, despite a massive gulf between the best and worst rates on the market.

Investors who buy their annuity from their existing pension provider are far less likely to buy an enhanced annuity, which pays out more income to smokers and those with certain medical conditions, based on a shorter than average life expectancy.

It is estimated that around a fifth of people exercising the OMO buy an enhanced annuity, compared with just 0.5 per cent who stay with their existing provider. Yet people qualifying for an enhanced annuity can increase their income in retirement up to 20 per cent a year by shopping around.

The conditions that can qualify someone for an enhanced annuity include high cholesterol, high blood pressure, diabetes, liver conditions, Parkinsons, heart disease and cancer.

Douglas Baillie, Perth-based pension specialist and founder of comparemypension.com, said users of the service, which helps investors amalgamate their pensions and increase their pension income by an average of 16 per cent a year.

“If they are in ill health or are smokers we can always increase their pension income,” said Baillie. “There is a lack of awareness that people have a number of options, and they should find out what these are before taking any action.”