Why annuity rates won’t go back to the Seventies
Saturday 10 May 2014
By Dan Hyde
Annuity rates hit double figures when Ted Heath was in No.10. But even a rise in interest rates wouldn't bring those days back
Savers in their 50s and 60s hoping rising interest rates will provide a hefty increase to the income paid by pension annuities should not hold their breath, analysis conducted for The Telegraph suggests.
Since 1990, the rates on annuities, which provide a guaranteed income to last through retirement, have fallen dramatically.
In October 1990, each £100,000 converted into around £15,500 for a 65-yearold man. Today, the typical annuity provides about £5,600 for that sized pot - roughly a third of the annual income per pound saved.
About 400,000 people every year were being locked into these low payouts before the Government announced in March that from April 2015 there would no longer be an obligation to purchase this insurance against outliving your savings.
Despite the reforms, around 200,000 people are still expected to opt for the security of an annuity each year - at least with part of their pension - and will be hoping for payouts to improve by the time they retire.
The two decades of falling annuity rates coincided with plummeting returns on UK government bonds, called gilts. This was no coincidence, as so-called gilt "yields" are used by insurers to price annuities. The yield on 10-year gilts has fallen from more than 10pc in 1990 to just 2.65pc today.
It would be reasonable, then, to expect a return to more "normal" interest rates would push annuity payouts back to their previous levels. The Bank of England is under pressure to raise rates as the economy recovers and to cool the housing market, which is deemed by some to be overheating.
This might push up the rates on gilts and give a timely boost to savers approaching retirement, or who have delayed taking an income from their funds.
However, analysis of historic government bond returns by Alan Steel Asset Management, a financial advice practice, suggests that "normal" for gilt yields is much lower than the levels recorded in the early Nineties.
Alan Steel, the firm's founder, compiled government bonds statistics since 1900 and established that the period from the Seventies to the turn of the millennium was "exceptional."
The data showed that in each decade from 1900 to 1969, the yield on 10-year bonds averaged as low as 2.9pc in some cases and no higher than 6.5pc. Then it averaged 11pc between 1970 and 1979 and 11.2pc between 1980 and 1989.
Between 2000 and 2009, when the Bank of England cut Bank Rate to its record low 0.5pc and started flooding the economy with money, the yield averaged 4.4pc. In no year was it higher than 5pc.
Yield on 10-year gilts, 1990-2009
Highest rate (year)
1900 to 1909
1910 to 1919
1920 to 1929
1930 to 1939
1940 to 1949
1950 to 1959
1960 to 1969
1970 to 1979
1980 to 1989
1990 to 1999
2000 to 2009
Source: Alan Steel Asset Management; Barclays Equities Gilt Study 2013
Mr Steel said that while annuity rates might climb a little if interest rates rose, the "normal" level was not 11pc but nearer 4pc or 5pc.
"It's not difficult to see that interest rates and inflation rates took off in the UK from late 1969 onwards as those born in the babyboom years - 1945 to 1949 - hit employment, causing demand inflation to rise," he said.
"As this huge generation started to buy properties, seeking loans, with the shortages in both areas, house prices and interest rates rose sharply. This was a one-off set of circumstances unlikely to be repeated in the UK. You only have to look at stagnating birth rates since the second baby boom, which ended in 1963, to see pressures have come off interest rates and inflation rates."
In late 2008, just before the Bank of England started its "quantitative easing" scheme, a 65-year-old could get £6,747 on an annuity bought with £100,000, according to Annuity Line, a broker. The gilt yield then was 4.4pc.
Paul Taylor, of financial advisers McCarthy Taylor, said he expected annuity rates to return to nearer that level. "Our belief is that quantitative easing cannot go on forever and that the inevitable pressure to stop borrowing to support markets cannot be avoided. So we anticipate increased gilt yields and therefore annuity rates to occur at some point."
The pricing of annuities is also determined by the life expectancy of customers, which has increased substantially since the early Nineties. In 1989, the average 65-year-old man was expected to live for a further 12 years and two and a half months. This year, the average 65-year-old is expected to live for another 18 years and one month.
This means that insurers expect to pay income for longer. Analysis by asset manager Blackrock last month found that this was a major reason for the cost of providing a retirement income doubling in 40 years.
Quote courtesy of The Telegraph
Saturday 10 May 2014