(James Saft is a Reuters columnist. The opinions expressed are
By James Saft
March 20 British retirement savers will benefit
greatly from new pension rules, though inevitably some will
squander the opportunity.
Still, better to make one's own mistakes than have them made
for you by a system which, as it was, laid out a banquet for
pension providers and produced table scraps for savers.
Under reforms announced on Wednesday, Britain will scrap
pension rules which obliged about 75 percent of retirees with
defined contribution, or 401k-style, pension plans to buy
Instead, most savers will have far more freedom to allocate
their pensions as they like at the age they become eligible to
take them, with the ability to take more money sooner and to
invest more or less as they wish.
The problem with the annuity system, which was designed to
protect savers from themselves by insuring they had a stable
income in retirement, was twofold; low interest rates and the
lousy value offered by annuity providers.
The story illustrates key problems in private pension
provision, and shows just how difficult it is to design a system
in which savers are treated fairly and are given the best chance
of an adequate retirement income.
Ideally pension systems either need a reasonable alignment
of interests, as in defined benefit plans in which the company
is on the hook for promised benefits, or a reasonable balance of
power between consumers and providers.
The British system, as it was, had neither.
In essence British retirement savers represented a captive
market for insurers selling annuities. While it is hard to know
exactly how bad the deal was which annuity sellers were
offering, a look at their share prices after the news broke that
their products were now only optional is a good guide. Legal &
General (L&G), one of the largest such providers, saw
its shares fall by as much as 15 percent after the news, despite
the fact that its entire retirement division, which sells far
more than annuities, produces less than a third of its revenues.
Other annuity providers also fell, notably Aviva Plc,
down 5 percent Wednesday, and Prudential down about 4
percent. Ratings agency Fitch commented on Thursday that while
much of the former annuity money would flow to other investment
products, those were likely to have a lower margin for sellers.
It should also be noted that the market segment with perhaps
the worst reputation for value among annuities was those offered
to people with documented health problems, whose shortened life
expectancies made them particularly rich pickings.
AN ACCIDENTAL VICTIM
The broader problem with annuities, of course, was one
no-one saw coming: the lowest interest rates in British history.
As market interest rates are the most powerful force in setting
how much an annuity pays on a given lump sum, savers who came to
retirement in recent years, after the Bank of England cut rates
to all-time lows, saw a huge drop in what they could expect by
way of income.
That's an accident of history, but one which produced
long-term suffering for those who came to retirement amid low
While it is possible that we now live in a
low-interest-rate, low-return world, the annuity system offered
no way for savers to hedge the risk that returns would actually
be good in coming years.
In defense of the industry, an annuity represents a transfer
of risk, from the individual to the seller, who must pay up
regardless of market conditions. That's a genuine service and
deserves a return, just likely a lower one than British
companies have been able to extract.
To be sure, this reform, like so many others, will produce
some perverse results. Buy-to-let flats come to mind as the kind
of thing many British retirees may find attractive - after all
property only ever goes up, right? People who put their pension
money into leveraged, illiquid and very likely overvalued single
assets are likely to wish in 20 years time they'd lost money
little by little instead with an annuity.
The new system is an improvement as it devolves power down
to those most concerned and with the best information about
their personal situations, needs and desires: the saver.
Offering that kind of adult autonomy to people who are,
after all, adults, is worth a great deal.
You never know, some might even buy annuities, especially if
the rates in a no longer captive market improve.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at email@example.com and find more columns at blogs.reuters.com/james-saft)
(Editing by James Dalgleish)