Secondary Annuity Market? What Secondary Annuity Market? | Wolters Kluwer Financial Services
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  • Secondary Annuity Market? What Secondary Annuity Market?

    By Martyn Oughton

    Published June 13, 2016

    HM Treasury (HMT), HM Revenue & Customs (HMRC) and the Financial Conduct Authority (FCA) have all during April 2016 published further proposed details of the secondary annuity market – originally proposed for 2016, now to be introduced in April 2017. HMRC has estimated about 300,000 people will take advantage of this facility when it is launched, but as things stand at the moment, the market for sales of annuities to third parties appears to have more barriers than openings; and the question about the extent to which this market will actually exist in practice has to be asked.

    The government’s confidence in the planned success of this market could well be misplaced. This can be put down to a combination of structural factors and an understanding of how the market will work in practice. Right now, any assumption that the take up of this market is going to be as enthusiastic as it has been for those wishing to cash in pension plans in exchange for lump sums cannot be based on facts. And for this reason, the enthusiasm about such a facility has to be tempered somewhat.

    What is the secondary annuity market?

    There is no easy way to answer this question, because it is not possible to sum it up as a single action. Instead, this is a concept which is brought together by a number of different strands producing a particular set of actions which if executed, will effectively form a secondary annuity market.

    This is complicated because of the core transaction it is based around. If someone wants to exchange their annuity for a one-off lump sum payment which effectively replaces the future value of their annuity, then they will have to ask their current annuity provider to assign their annuity to a third party. That third party will then pay the annuitant a lump sum, in exchange for which it will take the place of the annuitant for the purpose of receiving the ongoing income payments from the annuity provider. This effectively means assigning the annuity over to a third party in exchange for an agreed price.

    This is where the “market” piece fits in. To enable such transactions to happen, and for the end result of annuitants receiving their cash, there have to be on the one hand, providers who are happy to see their annuity policies paying out to someone other than the original annuitant: there also have to be providers who are happy to act as third parties and receive these income streams. Also, there have to be financial advisers willing to advise annuitants on what is an important financial decision. Put all these elements together, with the right degree of regulation and clear tax rules, and hey presto! You have a market. Except of course, it is not that simple.

    The policy issue

    You might well ask what has brought this about. Essentially, it is an extension of the pension freedom rules introduced from April 2015, which in themselves were based on a government policy decision to enable people who had worked and saved for much of their lives to have much more control over what they do with their pension funds. Chancellor George Osborne subsequently stated his desire for this freedom to be extended to those who already have pensions in payment. (1)

    The critical difference is that, unlike pensions not yet in payment, where the tax rules can be changed to enable more ways to access plan proceeds, it is not so easy to apply this level of compulsion to existing annuity contracts which cannot normally be cancelled. So if you cannot introduce something compulsorily, you have to do the next best thing – create a marketplace where people want to participate. This is what the government has been consulting on since March 2015. But creation of this market is not proving to be simple.

    Willing participants?

    At the moment, it is not easy to see the extent to which players are looking to enter this market. Some firms have stated their clear intention to allow annuitants to assign their annuities to third parties, whilst others have thrown their hats into the ring and declared that they intend to accept annuities assigned from other providers. But at the time of writing this article (May 2016), the response from industry has not been overwhelming.

    The other set of parties needed to make this market work, the adviser community, have also not been too forthcoming over their plans to advise their clients on such transactions. However, there are genuine opportunities for those in wealth management, as assignment of an annuity frees up cash to be otherwise invested, if clients do not have a pressing need to spend this money straight away. But this is fraught with dangers, which have to be taken seriously.

    The barriers

    Unfortunately, there are a number of factors which look like they will be real stumbling blocks in the development of this market.

    Firstly, for advisers, the big issue is, if they advise their clients not to assign their annuity, then what happens if the client decides to go against their wishes and carry out the transaction anyway? This is a risk that is being experienced by advisers right now with people who have pensions with guaranteed annuity rates and are looking to give these up to either take a lump sum from their pension or a transfer. To help, the FCA has produced a factsheet for how to deal with insistent customers; but for secondary annuities, the regulator has not indicated that there will be further guidance forthcoming.

    So for advisers, will they necessarily want to take the risks associated with such advice? Some will, there is no doubt, but for many, the concern must surely be that unless those clients genuinely do not have a need for the income they are receiving, it will be hard to advise someone to give this up in exchange for a lump sum. Especially as this may or may not effectively replace their income in the long run. And even if they are advised to assign the annuity, will there be a risk of recourse in future years if the client runs out of money?

    The key difference is that unlike taking a lump sum from a pension policy, this is money the client does not yet have in his or her hand. With an annuity, it is income they are receiving today and to give this up, great care must be taken. In short, for an adviser, it is very much uncharted territory.

    A question of pricing

    For insurers who issue annuities, the latest HMT consultation (and the one published in December 2015) relaxes the original stance that they would not be able to buy back their own annuities.

    The original concern here was that if demand was too great, this would put pressure on insurers’ liquidity and solvency positions. These concerns now appear to have receded.

    And as for the higher value annuities, where profitability might not be an issue, then the question is – how do insurers price these buy-backs to make sure they are worthwhile? Granted there will more likely be market forces at play here, and the FCA has said that firms will not be allowed to charge more than reasonable fees to cover their expenses but what about the pricing? Each insurer will need to make an assumption about the potential future likely experience with the annuity and make sure it does not pay out a lump sum that will see it out of pocket.

    Also they will need to make some profit margin or it will not be a line of business worth pursuing. The question is, will market forces come into play here, as they do for the current annuities market, or will insurers be largely free to price as they see fit? This will depend on how any players participate. If there are few, there is a risk that annuitants may not be able to shop around, and receive completely fair value for their transaction.

    And then there is regulation

    Moving on from the development of the market, the FCA has chimed in with its proposals for the regulatory environment for this market. Reading these closely, it is clear to see that the FCA believes similar levels of protection should be afforded to those looking to assign their annuity, as for those taking a lump sum from their pension plan. A number of themes are recurring here, such as the need to provide risk warnings, and the requirement to signpost financial advice plus the Pension Wise guidance service. There are also some requirements that will not necessarily make this market easy to enter.

    Firstly, firms looking to participate on the “buy” side (including those insurers willing to buy back their own annuities), will have to obtain a new permission from the FCA. The problem here could be the length of time it takes to obtain new permissions. The FCA reserves the right to take up to six months to process such applications, and firms cannot carry out the business they are applying for until that permission has been granted. On top of which, firms are being asked to provide projections for people looking to assign their annuity, to show how much it would cost to buy an annuity today to give them their current income. Building the functionality for these projections could well be a costly exercise, especially where the firm’s likely market is going to be amongst the smaller value annuities.

    The other (and arguably most important) component that will need to be sorted very soon is the proposed criteria above which annuitants will need to have received advice before the transaction is allowed to proceed. However, this is likely to be a barrier for two reasons. Firstly, the cost of advice for such a complicated transaction is likely to be substantial, so there may be many annuitants who do not have other sources of income who will not be able to afford to pay for advice. Also, for those annuitants who fall beneath the threshold, how will they achieve the protection that they need to be assured that they will be receiving a good deal for their assignment?

    In addition to which, there are still some technical issues to iron out, such as how in practice the requirement for firms to obtain consent from contingent beneficiaries is going to work.

    The big danger

    The dangers in this market are quite clear to see, and for that reason, participation may not be as enthusiastic as originally envisaged. The reasons are partly structural, but also this is likely to be a much more complicated and expensive transaction than taking a lump sum from a pension plan. It is therefore unlikely that the secondary annuity market will ever be developed as fully as in theory it has the potential to be. And, given the role that annuities have historically played in providing guaranteed incomes from pension plans to millions of people, this might not be a bad thing.

    About the author:

    Martyn Oughton is a financial services professional with over 20 years’ experience in the industry. He has been a compliance professional since 2007. In 2009, he became a Professional Member of the International Compliance Association (ICA), and has recently been an examiner for the ICA, marking exam papers and assignments for their UK and International Compliance, Anti-Money Laundering and Financial Crime Diplomas. A regular contributor to Wolters Kluwer Financial Services’ Compliance Resource Network, he also regularly writes for the ICA’s members’ journal “inCompliance”, and is also a freelance business-to-business copywriter and article writer.


    (1)  Chancellor Osborne’s quotes on this subject can be found in the HM Treasury press release dated 15 March 2015 – “Pension freedoms to be extended to people with annuities”.

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