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Perfect storm for annuities 'could see drawdown become the default'

by John Greenwood
August 25, 2016
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A perfect storm for annuities of falling interest rates and soaring demand for gilts could lead to drawdown becoming default retirement option, experts are warning.

A combination of market reaction to the economic prospects of the UK post-Brexit and soaring demand for gilts from DB schemes is pushing yields to historic lows, making annuities increasingly less attractive. Post-Brexit, 15-year gilt yields on which annuities are based fell to an all-time low of 0.9 per cent on 11 August. Annuity rates will in turn fall further, ultimately making them unpalatable, pushing retirees towards income drawdown, says Alliance Trust Savings.

Research from Hymans Robertson shows demand from DB schemes to transact bulk annuity buy-ins will reach £350bn by 2026, triple today’s levels and exceeding market capacity by £125bn. Hymans says DB schemes and insurance companies will look to buy over £300bn of gilts over next ten years, putting further pressure on yields.

Annuity prices, which are based on the 15-year gilt yields, have declined considerably over the eight years since the global financial crisis as more investors have moved their funds to the safety of government bonds resulting in an increase in bond prices and a reduction in gilt yields. The low interest rates in recent years have also made bonds more attractive than cash, pushing up the price of gilts.

Alliance Trust Savings senior pension proposition manager Brian Davidson says: “At such low prices, annuities will be unattractive for many more people, with the disadvantage of very low levels of income far outweighing the benefit of income certainty. Rates fell further following the Bank of England’s Monetary Policy Committee‘s cut to the base rate of interest at the start of August and, with speculation around a further base rate cut later this year, annuity rate rises seem unlikely. A ‘perfect storm’ has been created with the danger being that annuities will simply become unpalatable, resulting in more individuals considering drawdown as the main means of providing a retirement income.”

Hymans Robertson head of buyout solutions James Mullins says: “Our research shows that, over the medium term at least, demand from DB pension schemes to complete bulk annuity transactions is likely to exceed the capacity insurers active in this market are able to supply.

“To give a sense of the scale of the mismatch, if we were to assume a 5 per cent increase in insurer capacity year-on-year, then in ten years that would equate to £225bn of supply. That’s still £125bn short of total demand. Even when taking a more optimistic year-on-year growth of 10 per cent over the next 10 years we’d still be looking at a £65bn shortfall.”

 

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