Effect of Reforms to Compulsion on Annuity Demand

Edmund Cannon (University of Bristol) Ian Tonks (University of Bath)

and Rob Yuille (ABI)

Presentation at NIESR Conference on Future of Pensions, 11th December 2015

The big picture: removal of CA• Policy objective “supporting savers”

– “With the right consumer guidance, advice and support, people should be able to make their own choices about how to finance their retirement. Everybody’s circumstances are unique and it should not be for the State to dictate how someone should have to spend their savings” (Para. 1.7, HM Treasury March 2014)

• Pros and cons of compulsory annuitisation:• Protects state against moral hazard & individuals against myopia• Reduces (adverse) selection problems: ensures efficient large market• Reflects tax advantages given to pensions

– BUT• Redistributes wealth away from poor (short-livers) to rich (long-livers)• Inflexible:

– eg. prevents individuals bequeathing pension wealth

Regulatory time-line

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

A-day:AprilNormalMin.PensionAge=50

RelaxCompAnn AnnounceJune

RelaxCompAnn AnnounceJune

AbolishCompAnn AnnounceMarch

RelaxCompAnn Implement March

AbolishCompAnn ImplementMarch

RDR:Jan

Abolish Contracting OutApril

Gender neutralDec

NormalMin.PensionAge=55April

Relaxation (2010) and Removal (2014) of compulsory annuitisation

• Prior to reforms: compulsory annuitisation at age 75• Relaxation in 15th July 2010 Consultation

• Implemented April 2011– Three choices at retirement:

• Annuity; • Capped drawdown (max withdrawal: 100% annuity rate); and • Flexible drawdown: subject to MIR (£20,000)

• Removal announced 19th March 2014• Implemented after 6th April 2015

– Three choices (+ free guidance):• Annuity• Drawdown (?)• Cash withdrawals subject to marginal tax rates from age 55

– Transitional regime for 2014/15• More flexible drawdown; small pots/trivial commutation

Research questionsWhat has been the effect of both the 2011 and 2014 reforms on: • Sales of annuities & drawdown products?• Size distribution of annuity sales

– Predict: increased limits on trivial commutation affected the lower end of the annuity market more

• Age distribution of annuity sales– Predict: More sensitivity to reforms at younger ages

• Different types of annuity product?• Financial advice/guidance

– Predict: Effect of the RDR to cause financial advice to be concentrated on larger pension pots

Data 2007:Q1-2015:Q3

• Data provided by ABI from quarterly survey of ABI data providers

• Quarterly annuity and income drawdown sales aggregated across providers, by

• Product type• Internal/external • Age of recipient • Size of purchase• Financial advice

Quarterly Sales of Annuities/Drawdown0

5010

015

0N

umbe

r of p

urch

ases

(tho

u)

2010June

Budget

2011Change

2014Budget

2015Change

Annuities Drawdown0

1000

2000

3000

4000

Tota

l pre

miu

ms

?'m

2010June

Budget

2011Change

2014Budget

2015Change

Annuities Drawdown

Panel A: # Contracts (000s) Panel B: Value of sales (£m)

Average Size of Annity/Drawdown Contracts

2040

6080

100

Mea

n si

ze o

f pur

chas

e ?'

000

2010June

Budget

2011Change

2014Budget

2015Change

Annuities Drawdown

• Increase in size of annuity purchase

• Decline in size of drawdown purchase

Estimates (1) (2) (3) (4) (5) (6) Annuities: no

of contracts (thou)

Drawdown: no of contracts

(thou)

Annuities: total

premiums £m

Drawdown: total premiums

£m

Annuities: average

premium £'000

Drawdown: average

premium £'000

Constant 111*** 7.11*** 2,770*** 576*** 25*** 80.4***

(2.41) (.638) (74.3) (43.8) (.875) (2.08)Policy change 2011q2

-14.9*** -2.22* 308* -213** 7.06*** -7*

(3.75) (.992) (116) (68) (1.36) (3.24)

Policy announce 2014q2

-66.9*** 9.87*** -1,808*** 651*** 13.4*** -3.06

(4.98) (1.32) (153) (90.2) (1.8) (4.3)N 35 35 35 35 35 35r2 .904 .643 .822 .62 .818 .202

Standard errors in parentheses * p < 0.05, ** p < 0.01, *** p < 0.001

Distribution of Annuity Sales by Size of Annuity Purchase

• Fall in annuity sales

• Particularly for small pots

050

,000

1000

0015

0000

2009 2010 2011 2012 2013 2014 2015

< £5,000 £5,000-£49,999£50,000-£99,999 £100,000-£249,999£250,000 and above

Estimates of ln(# annuity sales) by size

(1) (2) (3) (4) (5) < £5,000 £5,000 to

£39,999£40,000 to

£99,999£100,000 to

£249,999£250,000 and

aboveConstant 10.6*** 10.8*** 9.62*** 8.28*** 11.6***

(.103) (.0699) (.0518) (.0543) (.0675)Policy change 2011q2

-.382* -.147 .201** .237** -.152

(.137) (.0925) (.0685) (.0718) (.0893) -32% -14% 22% 27% -14%Policy announce 2014q2

-1.66*** -1.28*** -.928*** -.716*** -1.22***

(.155) (.105) (.0776) (.0814) (.101) -81% -72% -60% -51% -70%N 27 27 27 27 27r2 .876 .89 .859 .763 .889

Dependent variable is the log of the number of policies purchased. Standard errors in parentheses * p < 0.05, ** p < 0.01, *** p < 0.001

Figures in red approximately convert the regression coefficients to percentage falls (= exp(betahat) - 1).

Percentage Distribution of Annuity Sales by Age

• Peaks in annuity purchases at 60 & 65• Relative decline in annuitising at younger ages

010

2030

No.

of p

urch

ases

(tho

u)

2010June

Budget

2011Change

2014Budget

2015Change

Age 55 Age 60Age 65 Age 70

05

1015

2025

No.

of p

urch

ases

(tho

u)

55 60 65 70 75age

2010q1: before changes2012q1: after 2010/11 policy change2014q1: just before 2014 Budget2015q3: after 2014/15 policy change

Panel A: Panel B:

Estimates of ln(# annuity sales) by age

(1) (2) (3) (4) Age 55 Age 60 Age 65 Age 70Constant 1.43*** 2.9*** 3.06*** .161

(.108) (.0688) (.0636) (.108)Policy change 2011q2

.308* -.282** .114 .283

(.143) (.0911) (.0842) (.143) 36% -25% 12% 33%Policy announce 2014q2

-1.17*** -1.33*** -1.04*** -1.06***

(.162) (.103) (.0954) (.163) -69% -74% -65% -65%N 27 27 27 27r2 .686 .909 .843 .642

Standard errors in parentheses* p < 0.05, ** p < 0.01, *** p < 0.001Dependent variable is logarithm number of policies purchased.

Dependent variable is logarithm number of policies purchased. Standard errors in parentheses. * p < 0.05, ** p < 0.01, *** p < 0.001

Figures in red approximately convert the regression coefficients to percentage falls (= exp(betahat) - 1).

Effect of Min. Age Rules on Annuitisation

05

1015

No.

of p

urch

ases

(tho

u)

2010June

Budget

2011Change

2014Budget

2015Change

Age 50 Age 51Age 52 Age 53Age 54 Age 55Under 50 Under 55

Proportions of annuitants & drawdown recipients using financial advice

0.2

.4.6

.81

Type

of a

dvic

e (s

hare

of m

arke

t)

2010June

Budget

2011Change

2014Budget

2015Change

Annuities: Independent Annuities: RestrictedAnnuities: Non-advised Drawdown: IndependentDrawdown: Restricted Drawdown: Non-advised

• Decline in purchases via IFAs of both annuities & drawdown

Summary impact of abolishing CA on annuity market

• Large fall in purchase of annuities from peak of (annualised) nearly £16 billion in 2012 to nearly £5 billion

• Increased use of drawdown– Increase in size of annuity purchase– Decline in size of drawdown purchase

• Larger annuity pot sizes: – small amounts taken as cash

• # annuities purchased <£5,000 fell by – 32 per cent after the 2011 change and – further 81 per cent after the 2014 announcement

• Peaks in annuity purchases at 60 & 65– Relative decline in annuitising at younger ages

• Decline in purchases via IFAs of both annuities & drawdown

If no annuitisation: Optimal decumulation strategy?

• Highly complex, depends on eg – Anticipated investment returns & longevity prognosis – Drivers e.g. bequests, long-term care provisions– Attitude to risk, behavioural finance & costs

• Defer annuitisation; but optimal to annuitise around age 80 for males:– Drawdown may be best if risk aversion low or desire to bequeath– But growth asset exposure needed to offset mortality drag

• Cognitive problems of elderly:– FSA (2006) survey of financial capability found over-70s performed worst of all

age groups– Dementia risk doubles every five years after age 60

• Need for Financial Advice

Conclusions

• Reforms have led to a significant decline in sales of annuities

• Drawdown sales have increased• Future trends uncertain as the market settles• Main effects at small-pots end of market

– Increase in size of average annuity purchase increase– Decrease in size of drawdown purchase

• What is appropriate decumulation strategy for pension wealth?

• For many annuitisation remains best alternative– Nudge policies?