People are born. They grow up, go to work, earn money, save some of it, pay taxes and eventually retire. They hope the money they have saved, along with what the state might chip in and what support their families might provide, will see them through their non-working years.
In the U.K., most workers believe they will need to plan for their own retirements, and are not expecting any support from the government. Workers also want to be able to purchase insurance and financial products that reflect their individual risks. This market profile differs notably from that of other countries: in some, pooling of risk and community rating are normal, and in others, the idea that the state will look after citizens is alien. The U.K.’s International Longevity Centre’s recent report “Making the System Fit for Purpose” says that for customers, the three most important elements for retirement income are:
- A guarantee of money to pay bills into their 90s;
- Certainty that retirement income will, at least, keep up with inflation
- Flexibility to receive more income or less, depending on yearly needs
Annuities can provide a guaranteed fixed income for life in exchange for a lump-sum payment, making them a good way to meet the first two needs. This article will discuss the growth and development of the U.K.’s enhanced annuity market, the recent legislative changes restricting its growth, current market drivers, and the building blocks that might enable this annuity framework to translocate to other markets.
How did the U.K.’s enhanced annuity market develop?
The U.K. market began gradually in the mid-1990s, with a simple proposition from two specialist insurers: As an unhealthy smoker is likely to die sooner than a healthy non-smoker, smokers with a pension pot can receive an annuity with enhanced terms that will provide a higher monthly income than a standard annuity, because it would not need to be paid for as long. Not surprisingly, smokers with large pension pots and savvy Independent Financial Advisers (IFAs) were enthusiastic about this proposition, and in 1995, the first “official” enhanced annuities were introduced and the market was born.
The number of impairments that can be underwritten for annuities rapidly grew to encompass other lifestyle factors as well as moderate and even severe medical conditions such as cancer, cardiovascular conditions, kidney failure and stroke. Mainstream life insurers soon took an interest in offering these annuities as well, to prevent being selected against in the risk pool and to select against their competitors in the standard annuity market.
The popularity of these annuities, as well as their complexity, surged in the U.K. over the next decade-and-a-half—by 2007, the market was approximately £1 billion and growing fast. Insurers and reinsurers knew they needed to develop ways to streamline the underwriting process, which resulted in the development of tools such as dedicated automated underwriting and data exchange platforms and the Common Quote Request Form (CQRF), which standardized the deep level of information-gathering from pre-retirees needed for speedy and strong underwriting. (A sample of the CQRF can be found here.) The market has since continued to surge, and by year-end 2013, reached nearly £4 billion—approximately one-third of the U.K.’s entire annuity market by premium size.
The enhanced annuity market’s rapid growth was assisted by the fact that in the U.K.—at least prior to April 2014—pension holders were required by law to annuitize their individual defined contribution (DC) pension pots.
Life insurance companies that managed employee pensions routinely sent pre-retirees a “warm-up pack” well in advance of their anticipated retirement dates. In the pack was information about pension rollover options and an offered annuity rate, should the pre-retiree opt to roll the pot into one of the insurer’s standard annuities. In 2013, the Association of British Insurers’ compulsory code of conduct on retirement choices required pension and annuity providers to educate pre-retirees about the “open market option” for annuities prior to retirement, and so included information to encourage pre-retirees to go into the open market to research other annuity options.
Not surprisingly, most pre-retirees (10 years ago this could easily have been 80 percent) took the simplest option, rolling their pension pots into annuities sponsored by the same life insurance company with which the funds were accrued without ever checking competitive annuity rates from other providers.
The government was concerned that too few people were using the option of shopping for better rates, and that this internal rollover to the existing insurer was ultimately creating poor outcomes for customers. As the low interest rate environment that emerged after the 2008 financial crisis stretched on, returns from annuities came under increasing pressure and customers were starting to perceive annuities as poor value.
The result of this pressure was a sweeping revision to the pension system in 2014 that effectively did away with all restrictions on how retirees could use their pensions. Customers now had a choice: they could purchase an annuity from any provider, take their pension pots in cash, or leave the pots invested on an insurer’s platform, drawing down funds as and when required.Read More +