Why Government should encourage schemes in wind up not to buy annuities
by Dr. Ros Altmann
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The case for stopping annuitisation
Trusteesof schemes in wind up should be instructed to stop purchase of annuitiesimmediately. There is a strong case for asking trustees not to purchaseannuities for schemes in wind-up. The purchase of annuities willmean that there will be less assets left to fund ongoing pensionsover time. The PPF is based on the idea that it is more efficientto run the schemes on an ongoing basis, rather than purchase annuitiesand it seems difficult to understand why this principle should bedifferent for current wind-ups, which will be eligible for assistancefrom the Government’s ‘Assistance Fund’. Sincewe do not yet know which schemes will be eligible, surely all schemesshould stop buying annuities, until the situation becomes clearer.
The reasonsto stop buying annuities include:
1. Annuitiesentail increased costs, due to insurance company profit margins:
It ismore costly to buy annuities, than to run the schemes on, becauseinsurance companies make a profit on annuity business (otherwisethey would not offer them!) and this profit margin entails a reductionin scheme assets.
2. Bulkannuity market is not functioning in the consumer’s (trustees’)interest – only two providers in the market for bulk annuities:
OnlyLegal and General and the Prudential offer bulk annuities for windingup schemes and from time to time, there may only be one, as theinsurance companies do not always have the reserve backing availableto offer bulk annuity business. This is not a well-functioning market,and the trustees do not have any buying power to shop around forgood quotes, because there are not enough providers to shop aroundwith!
3. Annuitypurchase exacerbates the unfairness of the priority order:
The resultof buying annuities is that the scheme assets will be even moreunfairly divided up than is required by the windup priority order.Those already retired will be taking a larger share of the assets,due to the costs of annuity purchase, and this leaves less assetsfor the non-retireds, meaning they will eventually get smaller pensions.
4. Costsof Government assistance are likely to be lower if annuities havenot been purchased:
If Governmentis to offer an assistance scheme, it will be cheaper to run on anongoing basis, just paying out pensions over time. Once annuitieshave been bought, the costs of any top up assistance rise and thetaxpayer will potentially need to pay more than would be the caseif the annuities were not purchased.
5. Annuitypurchase usually includes members who are not traced, wasting valuableresources:
Whentrustees buy annuities for a scheme in wind up, they usually purchasepensions for members they have not been able to trace, in case thesemembers subsequently come to light and want to claim their entitlements.This means that the schemes are buying annuities for people whomay not even exist, and therefore some of assets will be wasted(and the insurance company will pocket the extra money). This moneywould be better deployed on giving more to other members. If anassistance scheme is run on an ongoing basis, pensions will onlybe paid to members who lodge claims and no assets will need to beset aside for people who may not exist!
6. Purchaseof index linked and deferred annuities is particularly expensive:
The purchaseof index-linked annuities is particularly poor value at the moment,because of the lack of backing assets. Purchasing such annuitiesis sapping far too much from pension schemes, leaving far too littleto divide among other members. If the trust fund is run on an ongoingbasis, the profit margin for the insurance companies would be availableinstead to the scheme members.
1. Surelybuying annuities now will at least offer a ‘guaranteed’outcome for one group of members.
The costof this ‘guarantee’ is not justified. There could besome guarantee for some members, but the purchase of annuities willmean that this guarantee of income for pensioners is bought at theexpense of those members who are not yet retired. If the schemebuys annuities for all members, then even more of the assets willbe lost to insurance company profit margins and risk margins. Bothlevel and index-linked annuities are poor value – especiallydeferred annuities – and this means that too much of the assetswill be used to secure an income for the group which gets the fullestentitlement (pensioners), to the detriment of other members. Ifthe trustees are supposed to look after all members’ interestsand given that we know an assistance scheme is a possibility, itwould make sense to wait before buying the annuities, to see whowill be helped and how. It will be cheaper in the long run if pensionsare paid out over time, it will be more cost-efficient for the taxpayerif assistance is needed on an ongoing basis, rather than an amountof money to pay out the replacement ‘assistance’ pensionsfrom day one.
2. Annuityrates may worsen, so schemes should buy now.
Interestrates are rising, longevity forecasts have already been revisedupwards and annuity rates could improve or worsen – it isnot a one-way bet. Insurance companies will be pricing in expectedfuture demographics and will have been widening their risk marginsin the last couple of years. Since there are only two providers– and sometimes only one provider – it is impossibleto argue that this market is functioning to offer good value tothe consumer. It may be, but equally, it may not be and trusteescannot be sure that they will be better off buying now. Of course,the insurance companies will tell them that rates will worsen, toencourage purchase, but this may turn out to be wrong.
3. Atleast buying out level pensions will secure something.
The problemis that buying out level pensions will still mean that more of theassets are used for this one group than might be necessary if thefunds are run on an ongoing basis. Until we know more about howthe assistance fund will work, which schemes and members will beentitled and so on, the trustees are at risk of favouring one groupunfairly over another. Also, it would perhaps be better for theGovernment itself to write the annuities and pass on any profitmargin to the taxpayer, rather than to the Prudential or Legal andGeneral shareholders.
4. Annuitiesoffer good value and a guaranteed income.
If annuitiesare such good value, why is the PPF not planning to buy them? Firstof all, there are only two providers for bulk annuities, secondlyindex linked and deferred annuities have become extremely expensive,thirdly the providers will be building in a profit margin, fourthlythe trustees will be buying annuities for some people they havenot traced and who may never come to light, so this money will simplysit with the insurance companies and be wasted, when it could beused to pay higher pensions to deferred and active members.
5. Whatabout the GMP?
Thisis one area where a real help from the DWP would be to agree totake over all the GMP and contracted out rights responsibility fromexisting trustees. Putting all members back into the state schemeautomatically would save enormous amounts of time and money fortrustees and release significant extra assets to be used for members’pensions. Buying annuities for the GMP is a very complicated andexpensive exercise and hugely wasteful in pension fund resources.The small amounts, different indexation requirements and complexityof this exercise suggest to me that purchasing annuities to matchthis liability is a dreadful waste of money. Annuities purchasedfor this purpose are very hard to justify.