"Impaired life" annuities set for robust growth

LONDON (Reuters) - With healthy pensioners living ever longer, at a cost to the annuity industry, providers of "impaired life" annuities to smokers and the sick are carving out a rewarding niche that looks set for heady growth.

With longevity rising, extended payouts to pensioners are already a major concern for UK insurers and investors, with Prudential (PRU.L), Aviva (AV.L) and Legal & General all taking heavy charges in 2007.

But others are finding profit in the changing landscape.

The market for enhanced annuities -- a higher income in retirement for those with an illness, job or lifestyle that could shorten their lives -- topped 1 billion pounds for the first time in 2007. That is up 35 percent on 2006 and more than double 2001 levels, according to consultants Watson Wyatt.

Industry observers say enhanced annuities, currently about 10 percent of the UK market, could grow to more than double or triple that, at a time of strong growth for all UK annuities. Savings are pouring into the annuity market as growing numbers of Britons approach retirement armed with cash pots from their defined contribution pensions.

"We believe, in the long run, that the potential is about 40 percent," said enhanced annuity veteran Mike Fuller, chief executive of specialist insurer Just Retirement JR.L.

"I am still of the view that a great deal more business should benefit from enhanced annuities than is currently taking place."

Unlike standard annuities, which offer a set amount of annual retirement income dependent on age or gender, enhanced annuities use more detailed information, from medical records to home address and job, to offer higher incomes for those expected to live for less long.

For consumers with what insurers refer to as "impaired lives", the upside is a higher annual rate for the lump sum invested at retirement, an attractive prospect when standard annuity rates have been dropping for a decade.

Some mainstream insurers say the enhanced market is still too unpredictable -- there is more volatility and variance in customers' lives -- but others see it as an opportunity to refine existing annuity products and offer more accurate prices.

MAINSTREAM JOINS THE FRAY

"The big life players in the UK will look to claw their way back into the impaired annuity market, which has been dominated until now by specialist players, because they have increasingly found their books of annuity business are weighted towards those who live longer," Wolf Becke, CEO of Hannover Life Re said. "They are being anti-selected towards healthier customers."

So far, the UK enhanced market has indeed been dominated by niche players, with Just Retirement, set up by the team which pioneered the products in the mid-1990s, and mutual LV= together accounting for about 80 percent of the total.

High street names, however, even those hit by longevity charges, from Scottish Widows to Legal & General (LGEN.L), are also arriving on the scene -- pushed by regulatory changes forcing insurers to offer more choice across the market, and by the rising cost of healthy annuitants.

And, say some, there is yet wider potential for these products in countries with similarly aging populations, such as Japan and Singapore.

Though the business is still too small to offset the rising cost of healthy pensioners living longer, enhanced annuities offer firms the opportunity to test the market for more tailored and individually priced business, either through traditional impaired annuities or through newer forms, including "postcode annuities", which offer quotes based on home addresses.

"One or two appear to be dipping their toes in the water in terms of postcodes. If that became widespread, it would have a big effect on the market," said Ian Naismith, head of pensions market development at Scottish Widows. "You would systematically be taking out people with relatively low life expectancies."

L&G, the only major provider of postcode annuities, says it has built on decades of data to refine its model.

"Insurance companies are trying to find a way of finding the best, most accurate, prices for each individual," said Simon Gadd, managing director for L&G's annuities business, adding postcodes were simply a "rating factor" -- a way of grouping customers -- and the business would evolve over time.

"The annuity market has been very simplistic in recent years. That now needs to change, and we are trying to lead that."

Postcode annuities helped L&G cushion a sector-wide drop in individual annuity margins in 2007.