Mortality and money purchase pensions

by David Davison   •  
A study conducted by Stanford University in California has suggested that by 2050 the population could have to work to the grand age of 85! Based upon their calculations currently we have 1.5 pensioners for every five employees, but by 2050 that figure will rise to four pensioners for every five workers. The report’s author suggested that “We have seen a doubling of human lifespan in the last century... even without anti-ageing strategies, retirement ages will reach 75 in a couple of decades.” Findings from the Pensions Policy Institute have concluded that “Even unskilled manual workers, who are likely to have the lowest life expectancy, can still expect to live 16 years after state pension age.” The government estimates that over the next 10 years approximately 600,000 people will cease smoking as a result of the new ban on smoking in public places. Continuing medical advances are all aimed at keeping us alive that bit longer. So while it’s good news that more of us should be around to receive our telegram from the Queen, it also adds up to a reduction in the retirement income available for those with money purchase pension pots. Annuity purchase is still, by far, the most common means of providing an income on retirement from a money purchase pension arrangement. Longevity is one of the major assumptions insurers will take into account when setting annuity rates, so these continued improvements can only push the cost per pound of pension provided up. This means that all other things being equal individual’s pension pots will provide diminishing incomes over time. What can individuals do to try and mitigate this trend? People need to realise that once they have accumulated their pension pot they have a range of choices as to how they provide themselves with an income in retirement. If a guaranteed source of income is an individual’s priority, then a traditional annuity may still represent the most appropriate option. Buying an annuity is a bit like buying car insurance, in that different providers will be competitive in different segments of the market at different times, so it pays to shop around. Too often in the past individuals took the annuity offer they received from the holding insurance company without being aware that they had the option to take their fund to the market and get the best open market option (OMO) rate available to them. Significant steps have been made in the communication of the OMO to individuals and members of schemes but still a significant number of individuals miss out on an improved retirement income. Never has it been more important for individuals to choose their options at retirement with great care. Do they want to inflation proof their pension and if so, at what rate? Will they need a spouse’s pension? Would they be eligible for an impaired life annuity which may reflect their poorer state of heath? Impaired life annuities offer those in poorer health better annuity rates, on the basis that the insurer doesn’t expect to have to pay them for too long, but by removing some comparatively poorer lives from the mortality pool they will undoubtedly begin to push annuity rates lower still for what might be described as ‘conventional’ lives. The continuing longevity improvements over recent years have also placed a substantial strain on the insurers providing the annuities. Clearly insurers have had to take a view on mortality as they secured business over time. Some of these historic views of mortality, while appearing reasonable at the time have turned out to be overly optimistic. With very little wriggle room in costing annuities it is likely that some insurers’ historic annuity books will be running at a loss. Insurers are unlikely to get much sympathy for their position; however, it does have an impact for the wider market in that insurers are likely to be even more cautious in setting assumptions for new business. This will tend to further reduce income for individuals and, if the losses are significant enough, could have an impact on the insurer’s solvency. Consequently the solvency position of the chosen annuity provider becomes an important selection issue for individuals when securing benefits. On the positive side, the annuity market remains attractive to a number of providers which should keep their terms competitive. Given this background there has also been a surge in demand for alternatives. So called third way products have sought to provide individuals with greater flexibility, combining the guaranteed income of annuities with some form of secured investment return. However, options such as income drawdown, unsecured annuities or scheme pensions have suffered as a result of the limitations on the supply of options and hedging vehicles required to make these products function effectively. They also still have to answer the fundamental question of how long will the income stream be required for. Some of these products effectively transfer the longevity risk to the individual, so that if your individual pot diminishes or runs out your income reduces or ceases. This is undoubtedly a complex area for individuals and they will need focused financial advice to effectively guide them through the myriad of choices. For further information please contact David Davison at Spence & Partners ( on 0141 331 1004. Issued on behalf of Spence & Partners by Blueprint Media This article was featured in Aug ‘09 edition of DC World, a Professional Pensions supplement. Date: August 2009 ENDS

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