Out-Law News 3 min. read

Annuities need innovation, but UK government should "tread carefully" before opening up pension freedoms to market, says expert

Plans to extend new pension market freedoms to existing annuity holders, potentially allowing them to sell the policies for a cash sum, would require careful consideration to ensure risks to consumers and buyers were minimised, an expert has said.

Steve Webb, the Liberal Democrat pensions minister, told the Daily Telegraph this weekend that he hoped to prepare proposals for the benefit of existing pensioners, who will not be able to benefit from more flexible pension laws due to be introduced in April, before the general election in May.

Pensions expert Simon Laight of Pinsent Masons, the law firm behind Out-Law.com, said that although Webb's idea to create a market in "second-hand annuities" was an "interesting" one, the UK government would have to "tread very carefully" before introducing it.

"Annuity providers will probably quite like the idea, as it removes one of the perceived barriers to annuity purchase: if you hand over your money forever, what happens if you need a lump sum in an emergency?" he said. "Customers might be more open to buying annuities if they know that they can sell them for cash, in an emergency - existing annuities do not allow this, or are perceived as not allowing it."

"However, the result could be that buyers purchase contracts that produce income linked to the lives of people that they have no connection with. In this case, is the contract still one of insurance or will it become gambling, which insurers are not licensed for? Buyers will also have to find a way to protect themselves from customers who know that their days are limited. Enabling insurers and other institutions to 'bundle up' individual annuities and sell them on in bulk could also create unquantifiable macro-economic risks, similar to the results of the trade in packaged mortgages before the 2008 financial crisis," he said.

Webb told the Daily Telegraph that the plans would require the agreement of the current coalition government, as well as cross-party support from the Labour Party to ensure that they could be implemented regardless of the results of the election. Laight said that without this agreement, the "chances were slim" that the plans would be taken forward.

From April, members of defined contribution (DC) pension schemes will be able to access their savings in whatever form that they wish, subject to their marginal rate of income tax, once they reach the age of 55. These new freedoms will be backed by a right to independent guidance at the point of retirement. Scheme members will still be able to withdraw up to 25% of the value of their pension pot tax-free on retirement, with any additional lump sum taxed at their normal marginal tax rate rather than subject to the existing 55% tax charge; and will be able to decide to purchase an annuity with the remainder of their savings or reinvest.

Webb said that his proposal would be of benefit to existing annuity holders, who had already used their pension savings to purchase an annuity giving them a guaranteed income for the rest of their lives. He said that existing laws meant that there was "very little that an individual [could] do if they would prefer instead to have a cash lump sum or some combination of cash and reduced income" once an annuity is in payment.

"I want to see people trusted with their own money wherever possible," he told the newspaper. "No one would be obliged to do so, but for those who would prefer up-front capital to regular income, I can see no reason why this should not be an option."

The proposals Webb discussed with the Telegraph would result in annuities continuing to exist once they had been sold, but the regular payment would instead be made to the new policyholder, most likely an insurance company or pension fund, until the original policyholder died. He said that this would require changes to "ancient" insurance laws, Treasury input on how the sale of the policy should be taxed and consumer protection measures.

"I have discussed this idea with a number of major players in the industry and there is considerable interest and enthusiasm for taking it further. It is possible to imagine, for example, a market in second-hand annuities with perhaps some financial institutions buying them from individuals and bundling them up to sell on in bulk," he said.

Laight said that investments in bulk annuities could be of potential interest to defined benefit (DB) pension schemes, such as final salary schemes. These schemes require sound underlying investments in order to guarantee members' pensions.

"These annuity bundles would be income-producing assets," he said. "If the profile of named lives is a near match to the profile of a final salary scheme's membership, then this could be a valuable partial de-risking tool."

He said that pricing or disclosure requirements could be implemented to prevent those with shorter projected lifespans or those suffering from chronic illnesses from trading their annuities for cash, but that these requirements could make the concept "uneconomic".

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