Government must clarify capital requirements if secondary annuity market is to be successful, says expert

Simon Laight of Pinsent Masons, the law firm behind Out-Law.com, said that the success of the planned reforms would depend on whether providers could offset annuities that they purchased against the pension and annuity liabilities already on their books. The proposals as published made this far from clear, he said.

However, with adequate support, 'bundles' of second-hand annuities would find likely purchasers among final salary schemes, existing annuity providers and reinsurers, Laight said.

"The 'buy side' of the market certainly exists," he said.

"Purchasing bundles of annuities can be beneficial if the relevant lives outlive expectation, resulting in the purchaser receiving income for longer than expected. This is a good counterpoint to the main risk that schemes, providers and reinsurers carry - namely that their members live longer than expected and that they have to pay out income longer than expected. The two risks can, if constructed carefully, be a good match," he said.

"The big issue on the buy side, however, is prudential regulation. For an annuity issuer, buying matching second hand annuities only works if for capital reserving purposes they are allowed to match those assets with their own annuity obligations. Under current rules, that is far from clear and, unless that can be clarified, the annuity companies won't enter the market and the market won't get off the ground," he said.

Laight was commenting as the UK government confirmed the removal of tax restrictions on the sale of annuities from 6 April 2017, allowing annuity holders to sell on their policies in exchange for a cash lump sum. The new right will be available in respect of individual policies, held in that person's own name; and will be backed by a right to free and impartial guidance from the government-backed Pension Wise service as well as a requirement for the policyholder to seek independent financial advice if the annuity is worth more than a certain value, to be confirmed.

The government has revised its original plans to allow annuity providers to buy back annuities from their own customers, subject to "robust safeguards", according to its response to the consultation published alongside the March 2015 Budget. All purchasers and intermediaries planning to participate in the new market will have to be regulated by the Financial Conduct Authority (FCA), which has also been asked to look into the need for extra consumer protections, such as dedicated risk warnings and ways for consumers to understand the value of the product they intend to sell.

The approach set out by the government would not allow annuity holders to "unwind" contractual agreements with their original provider, but would instead give them the ability to access the value of the product where a willing institutional third-party buyer was available. The annuity holder would receive a cash sum, taxed at their marginal rate of income tax, which they would be able to take as a lump sum or place into a drawdown product; while the provider would continue to make its regular annuity payments to the purchaser for the remainder of the individual's life.

The new right will only apply to annuities held by individuals, including joint annuities, and not to those held by pension schemes. Pensions expert Simon Laight said that this would effectively exclude many individuals from the scope of the new right, given that many existing annuities would have been purchased by trustees of occupational pension schemes for the benefit of the respective scheme members.

"These individuals will only be able to sell if the trustees first agree to assign the annuity into the scheme member's own name," he said. "Not all trustees will agree - they will be worried about the risk of claims later, that by allowing the sale they caused the member's, or the member's dependants', subsequent destitution."

However, he said that the Treasury's "U-turn" enabling providers to buy out their own annuities would be "music to their ears, especially for closed book providers who have huge books of small annuities".

"Each time an annuity is bought back, that releases an amount of capital within the insurer's reserves," he said. "Multiply that across the whole book and buy-back becomes a handy capital-releasing tool, which enhances shareholder value. This measure alone is likely to drive further corporate activity amongst the closed book providers."

Pensions expert Robert Lawrence of Pinsent Masons said that the government was correct to emphasise the consumer protection implications of the proposals, as cashing in annuities would not be in many people's best interests. However, the government should also "give strong consideration" to encouraging some form of bidding 'platform' to be set up, he said.

"This would enable the individual to obtain a number of 'bids' for their annuity without having to separately approach a number of providers, and would address some of the risk around the individual obtaining poor value for money," he said.