Retirees’ gain is insurers’ loss as annuities regime changes

Reform of annuities will drastically cut one source of funding for property, writes Alex Catalano

Annuities have provided UK insurers with a steady source of funds for real estate and real estate debt investment; the asset class is a good fit for their long-term liabilities. The product is one of their more profitable ones, worth £12bn a year in the UK.

So the shock Budget announcement that UK retirees would no longer be obliged to invest their pension pots in an annuity sent he industry into a tailspin. Legal & General chief executive Nigel Wilson says UK sales of individual annuities could plummet 75% to £2.8bn; rating agency Moody’s estimates a 50-75% drop in the near-to-medium term.

Aviva, the market leader in individual annuities, is likely to be the hardest-hit in the short term – its 20-year-old Commercial Finance business is based on channelling annuity money into commercial and PPI real estate lending (see below).

Ashley Goldblatt, head of real estate lending at Legal & General, the UK’s third largest individual annuity writer with around 11% of the market, says: “It’s nothing we’re worried about in the short term. We won’t let it deflect from what we’re doing in real estate, long leases or infrastructure.

“We have a very large booked annuity business and started our real estate lending business two years ago. We have enough headroom to keep going for years. The only pressure I’ve felt since the announcement is to get more money out the door.”

Goldblatt’s confidence is also because the changes don’t affect bulk annuities, where L&G is a leader. Last year they accounted for 70% of its annuity sales, and in March it  wrote the UK’s biggest bulk annuity, £3bn, for ICI’s defined benefits pension fund.

While the annuities shake-up will hit the main individual annuity providers in the short-term, the regime change opens up opportunities to offer alternatives. “We are developing our thoughts on products for retirees,” Mark Meiklejon, real estate investment director at Standard Life, says. “If the drivers are capital preservation and sustainable income yield, real estate as an asset class should feature very strongly.”

UK life insurers set to lose £12bn annual pension pot

The UK has Europe’s largest individual annuities market. UK insurers have sold around £11bn-12bn worth annually. Buying an annuity has been compulsory for most people with a pension pot saved via a defined contribution, or money purchase, scheme. In the UK, 75% of retirees buy annuities. In the US, where it is optional, the figure is 5%.

But from July 2015, subject to consultation,  anyone aged 55 in a money purchase scheme will be able to withdraw pension assets at any time with no cap on the amount, to do whatever they want with. This effectively abolishes the requirement to buy an annuity.

Retirees freed to do what they wish with their pension pot are likely to reinvest in more flexible and transparent products. Annuities are inflexible, opaque and costly; the rates they pay have fallen steadily in the past 20 years, partly because of falling gilt yields.

It is important to note that the new regime does not affect bulk annuities, which  are typically bought by defined benefit pension funds that are trying to derisk. However, the change will be a big challenge for UK life insurers, as individual annuities currently account for up to 50%  of the value of their new UK business.

Annuities shake-up is blow to Aviva’s property lending arm

Aviva will be hardest hit by the regime change. As well as having the largest share of the UK individual annuities market (20%), it is the only one of the big three players with an annuities-based real estate lending arm.

Aviva Commercial Finance writes long-term, fixed rate mortgages. It has been lending since 1984 and the 30-strong Norwich-based team has built up a £14bn portfolio of loans secured on commercial property, GP practices and PP property.

“On new business, we aim to invest about 20% in mortgages,” Aviva CF’s former head of lending Kevin Sale told Real Estate Capital in October 2010, but this figure fluctuates, depending on property returns’ relative attractiveness compared with other fixed-rate, long-term assets. In 2010, real estate loans made up £8bn of the £10.5bn book.

Since Sale retired last December the business has been merged into the fund manager Aviva Investors. A replacement for Sale has not yet been announced. No one from Aviva was available to comment, but the company said in a statement: “With increased choice comes increased responsibility for customers to ensure that they take the right long-term decisions and consider the risks that they may out-live their savings.”

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