Pension investors have already seen increases in longevity and poor returns on investments give their incomes a hammering. Now European Union (and EAA) solvency requirements, in the shape of Solvency II, risk turning the knife in the wound. With the UK’s insured annuity market dwarfing those of our Continental cousins, this is a problem that hits this country’s retirees more than those of any other.
The Committee of European Insurance and Occupational Pensions Supervisors is the body that advises the European Commission on what it.
The UK insurance community has been hoping for some watering down of the Solvency II requirements, which are designed to reduce the risk that an insurer cannot meet its claims and provide regulators with early warnings if solvency does become depleted. But the CEIOPS’ third and final set of advice on Solvency II implementing measures that was sent to the EC last month has not put Peter Vipond, Director of Financial Regulation at the ABI at ease.
Vipond says: “We are concerned about the continuing overtly cautious approach of regulators, whose desire for firms to hold extra capital is a step change from the original, and welcome, aims of Solvency II. It is excessive and fails to recognise both the strength of the life and general insurance industries, and how insurers work.
“Solvency II has the potential to provide many benefits to consumers and insurers, but, more work on its development is required. We will continue to work with the Commission and other stakeholders to find a suitable solution to these issues.”
Solvency II is designed to deal with exactly the sort of problems thrown up by crises such as last year’s credit crunch, a crisis that many insurance company professionals would say the industry has survived in remarkably good shape, particularly in comparison to other sectors.
The credit crisis actually proved a fillip for annuity rates up until the day that the Bank of England announced that it was to embark on a QE strategy. Until then corporate bond yields had risen substantially, but pumping money into the system created the opposite effect – a headache for scheme members coming up to retirement.
There used to be a constant correlation between gilt yields and swap yields but over the past couple of years the correlation has gone out of the window
Annuity rates fell by an average of 8 per cent last year, which is the biggest fall since 2002, when rates fell by 12 per cent, according to annuity specialist, Billy Burrows.
In January 2009, a £100,000 joint life annuity for a man aged 65 and woman aged 60 with two thirds spouse pension and level payments paid would get £6,439. By the time December came around, the same annuity would have paid £5,897. Annuity specialists fear Solvency II will make matters far worse.
Bob Bullivant from Annuity Direct believes Solvency II could have a devastating effect as it will mean that providers have to value annuity liabilities using gilt yields rather than bond yields as they do now.
The result will mean an increase in capital requirements, which according to best estimates will reduce rates by between 20 and 30 per cent, says Bullivant.
“What could this mean? To defer purchase or not?”, asks Bullivant. “Clearly, without a reliable crystal ball this a hard question. My view is that clients should undertake a cash flow analysis looking at the cost of deferral.
“The process is to look at the lost income over the proposed deferral period, look at what would be available today at current rates and calculate the amount of time for the extra income to recoup the income lost during deferral. This quantifies the issue based on current rates and you can feed in assumptions if rates increase. The normal conclusion is that deferral is high risk.”
Simon Gadd, managing director of annuity business at Legal & General agrees with Bullivant that EU meddling rather than factors such as QE will impact annuity rates. He says that there is a misconception that the end of QE will offer a respite for annuity prices.
“The whole credit crisis has affected annuities but the direct correlation is less clear.”
Gadd says that most annuity prices are driven by what L&G can generate from its investment strategies, which is a mixture of interest rate swaps, corporate bonds and some property and not gilts. You would have thought that if gilt yields go up so would annuity rates but that is a misconception.
“Annuity pricing is more directly linked to the yields on corporate bonds and swaps as well as property yields. There used to be a constant correlation between gilt yields and swap yields but over the past couple of years the correlation has gone out of the window. The situation at the moment is that yields on 20 to 30 year swaps are already lower than the yield on long dated gilts. If gilt yields go up as a result of QE ending it doesn’t necessarily follow that corporate bond and swap yields will follow.’
“The bigger issue is Solvency II and that could be far worse for annuity rates – there is going to be great deal of uncertainty for the next two years – but until then I think that annuity rates will