While it may only be a gentle 0.25%, the recent rise in interest rates represents a notable change in direction for the Bank of England. It suggests the era of record low interest rates is finally starting to reverse. Annuities have been a notable victim of loose monetary policy, with unattractive yields seeing retirees favouring drawdown. Does this change in environment tip the balance back towards annuities?
Even before this recent rate rise, annuities rates had already moved significantly since their nadir in 2016. Nathan Long, senior pensions analyst at Hargreaves Lansdown points out that annuity rates are 19% higher from their low in mid-September of last year, shortly after the Bank of England cut rates following the Brexit referendum. However, to date, it has not prompted any apparent rise in popularity. Annuity sales have fallen from around £11 billion in 2015, to around £4 billion today.
The recent rate rise hasn’t made a significant difference to this picture. Long says: “The important metric for annuity pricing is long-dated gilt yields, not interest rates themselves, though the interest rate has a knock-on effect. The recent rate rise was so widely anticipated that rates had improved quite significantly in advance of the announcement.”
In the wake of the announcement, gilt or government bond yields actually fell slightly. This meant that in the immediate aftermath of the announcement some groups were raising annuity rates.
There are also many other factors influencing the popularity of annuities other than the price. Jonathan Watts-Lay, director at employee benefits group WEALTH at work, says: “This is a marginal rise and investors are not particularly price-sensitive anyway. Before freedom and choice were introduced in the pensions market, most people would go to existing providers and wouldn’t get the best rate. They didn’t take enhanced annuities for example, or shop around. Consumer behaviour is not that sophisticated.”
He says that today a far more important factor is that people want control over their money. They don’t want to give it away to a faceless pension provider. He adds: “There is widespread mistrust of pension providers. When they read issues around schemes such as Tata Steel, they get concerned and would rather have the money in their bank account.”
Drawdown Without Advice
However, Watts-Lay believes there is a distinction between what people are doing and what they should be doing. He says some of the errors of the past are now being repeated in the drawdown market: “People are taking drawdown without advice, or are going with their existing pension provision rather than looking at all their options. Also, the tax take is some way beyond the level estimated by the government. It had forecast around £0.9 billion, but it has ended up being £2.6 billion. Maybe some people knew what they were doing, but I suspect some have had a nasty shock.”
That said, high transfer values have been a lure for people to swap into drawdown products – where retirees draw an income from money invested in the stock market – and here, there will be an impact from higher interest rates. However, neither Long or Watts-Lay believe it will be enough to influence investors. Long says: “Transfer values are still quite high from where they were. People who are going into retirement with final salary schemes worth sums they had never thought of.”
Watts-Lay agrees: “There has been the view that transfer values might decline, but we are still seeing transfer value worth up to 40x the retirement income. That is £800,000 versus an income of £20,000 per year. Against the backdrop of a general suspicion of pensions, even if that rate drops a little, it is still a huge amount to an individual.”
Among Hargreaves Lansdown clients, around 70% now take an “enhanced” annuity. Long says that the level of underwriting has significantly improved in the last 5-10 years, which means there are many more conditions for which people can get an enhanced annuity, including being overweight, drinking excessively, or smoking. He adds: “It may be because people don’t feel they get value from an annuity if they are in good health, but if they can get an enhanced annuity, they are willing to buy.”
Annuity prices have improved, but it has not tempted retirees back to the market, and the recent rate rise has made little difference. Transfer values are still attractive, and people still want control over their pot; it will take a bigger carrot than a small rise in prices to reverse the trend.
