Title: Annuity Rates Head South!

Author: Billy Burrows

Added on: 04/11/2008

There are more signs that annuity rates are about to drift downwards as Canada Life, Legal & General and Norwich Union cut their rates last week. This follows a significant cut by Prudential recently.

It seems almost certain that the Bank of England will start cutting interest rates in an attempt to stimulate the economy, providing the lid can be kept on inflation.

So what does this mean for annuity rates? First of all we don't subscribe to the view that annuity rates will be cut drastically and quickly, but we do believe that rates will drift downwards over the next few months.

The reasons why annuity rates may fall are as follows:

• Long term yields on gilts will probably fall as the government borrowing requirement increases but most annuity providers invest mainly in corporate bond yields and these yields may not fall as fast as gilts.
• The annuity market is very competitive and annuity companies will want to maintain market share and therefore will keep rates as competitive as they can.

However continuing concerns about inflation may limit downward pressure on yields. Some commentators say increased public spending will fuel inflation but others believe that falling oil and commodity prices the oncoming recession will drive prices down. Whatever the view, retired investors should always be wary of inflation and take steps to inflation proof their pensions.

Interestingly the yields on 15 year gilts are at the same level as one year ago at around 4.75%. This suggests that annuities are still priced at the same level when yields were over 5% in the summer.

The chart below shows the movements in annuity rates over the past 12 months. A £100,000 annuity will now pay nearly £300 per annum more compared to one year ago, an increase of 4%.

We predict that rates will indeed ease off and we would not be surprised if a £100,000 annuity was paying around £200 per annum less before Christmas, a fall of about 2%.

Therefore there is probably no need to panic into buying an annuity, but there will be a rush to look at the investment of pension funds.

The right hand axis on the chart plots the FTSE and shows that the index for the UK’s top 100 companies has fallen by over 35%.

Hopefully not many people approaching retirement will have suffered such a huge loss because they should have more balanced investments, but it shows that movements in equity prices can have a far greater affect than movements in annuity rates.

Whilst I feel competent to discuss annuity trends, I am not in a position to speculate on the stock market but the advice to everyone approaching retirement is to keep an eye on annuity rates and an even bigger eye on the investment of their pension funds. If equity prices do improve and the FTSE rises over 4500 it might signal time for those still fully invested to convert into annuities.

Those invested in cash or other safe funds may wish to consider purchasing their annuities sooner rather than later.

Billy Burrows - The Retirement Partnership