aquilaheywood's response to HM Treasury's consultation on creating a secondary annuity market

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1 aquilaheywood's response to HM Treasury's consultation on creating a secondary annuity market June 2015

2 Table of Contents Introduction 3 Our response to the consultation 3 Response to consultation questions 7 Other considerations on a secondary annuity market 13 In conclusion 14 Appendix - about aquilaheywood and our clients

3 Introduction We welcome the opportunity to respond to HM Treasury's consultation on creating a secondary annuity market. Our comments are set out in this document. To put our response in context, we have provided details about aquilaheywood and our clients in the Appendix. Our response to the consultation Why the creation of a secondary market for annuities should be considered An annuity is an inflexible and irrevocable insurance contract which provides the annuitant (and their dependants, where applicable) with a guaranteed income for the rest of their life. This provides income security, but the inflexibility of annuities means they might not be suitable for everyone and can result in difficulties where there are unforeseen changes in circumstances. The cost of annuities has increased as a result of improved longevity, very low interest rates and increased solvency costs required by annuity providers. Until the 2014 Budget, there was a requirement to purchase an annuity when DC funds were crystallised unless they were trivial. As a result of these factors, it is understandable that many annuitants who purchased annuities in the past feel they are 'locked into' an inflexible and expensive product that they may not have needed or wanted. The issue is exacerbated by the possibility that the annuity purchase process may not always have worked in the annuitant's best interest where the annuitant has not shopped around to purchase the best annuity the 'open market option'. This is a separate but related issue which we believe should be addressed, if required, by the regulator. We are surprised that the FCA is only now proposing to take action in the non-advised annuity purchase process 1. So in summary, annuities are Inflexible Irrevocable Compulsory (up to the 2014 Budget) Perceived as expensive Given this context, we can understand why a secondary market for annuities could appear attractive to some annuitants. 1 MS14/3.3: Retirement income market study: Final report - 3 -

4 Why the creation of a secondary market for annuities will be difficult Making changes to an insurance product with guarantees related to longevity is likely to be complex and hampered by changes in the state of health of the annuitant(s) and hindsight. We believe that it is unlikely that: An 'annuity buyer' would 'purchase' an annuity without ascertaining the state of health of the annuitant. An annuitant would 'sell' their annuity without taking some advice or guidance. Indeed we would support the concept that taking advice should be mandatory unless the value of the annuity is less than an agreed amount calculated on a standard actuarial basis such as used in Statutory Money Purchase Illustrations. The costs involved in medical underwriting and advice together with the administration costs in re-assigning the annuity and on-going existence checking will result in considerable costs. Annuity buyers will also want a reasonable profit margin, especially given the risks involved. It is likely that the annuitant will incur these costs. The consultation paper proposes that annuitants selling their annuity would have just 3 options: a lump sum cash payment, a flexi-access drawdown product or a flexible annuity. All these options would result in the annuitant s Annual Allowance being reduced from 40,000 to 10,000. We cannot understand why the annuitant should not be able to purchase a normal annuity on different terms provided by the original annuity provider or an alternative annuitant provider and retain the 40,000 Annual Allowance. Suppose the annuitant wants to sell the annuity to generate a cash sum. Clearly the amount of cash available will normally be significantly less than the annuity purchase price even allowing for the payments already made. As well as the costs referred to above, the annuitant will be older and the annuitant's health may well have deteriorated over the period. The consultation paper proposes that annuity providers can ban their annuities being traded and we can understand why HMT has proposed this. However that does mean that certain annuity providers will exclude themselves from the market which could frustrate annuitants especially if they are the ones with less competitive annuity rates. There are three more issues that make a secondary market for annuities difficult: It is possible that many advisers will not want to advise on selling annuities which could result in a lack of advice and/or more costly advice. Late notifications of death will be more prevalent where the annuitant is not receiving income from the annuity at the date of death. Joint life annuities introduce more complexities which make the selling on of annuities even more difficult

5 More flexibility for existing annuities? Perhaps an alternative would be for annuity providers to allow the annuitant to change the terms of the annuity that they have purchased in the event of a change in legislation or a change in the annuitant's circumstances recognising any deterioration in health. While the annuity provider would make a charge for the change, it could be more efficient than selling the annuity to a secondary-market purchaser. An example of a change in legislation is the increase in the trivial commutation amounts that have taken place over time with the amounts increasing to 30,000 in March We believe that where, at the original annuity purchase, the annuitant was not eligible for trivial commutation, but, with the increase in the trivial commutation level to 30,000, the annuitant would have qualified for trivial commutation then that should be an option for the annuitant. With new annuity structures becoming available following the Pension Freedoms, perhaps annuity providers would facilitate a product 'upgrade' to provide more flexibility. Alternatively, perhaps it would be more straightforward if an annuity could have a Cash Equivalent Transfer Value (CETV) based on the annuitant's age and state of health that could be used to transfer into the Pension Freedoms regime (without any tax-free element) rather than involving a secondary-market purchaser. These approaches seem to be more straightforward than selling the annuity to a third party. Like DB to DC transfers but more complicated Some of the considerations in this consultation are similar to the debate about DB to DC transfers. An annuity is like a DB pension at retirement and perhaps it would be sensible to have similar approaches about the need for advice. However, the longevity risk related to transferring out or selling on an annuity is borne by the annuitant, which depends on their state of health, whereas DB pensions do not typically allow for members' mortality risk. Accordingly, we believe it is even more important that annuitants take advice before transferring or selling on an annuity. Trivial commutation One consideration not covered in the consultation is trivial commutation. The limit for trivially commuting a pension has increased from 15,000 in 2006 to 30,000 in 2014; this means that there are a number of individuals who were probably forced into purchasing an annuity (as their funds were too small to support drawdown) that would now have been able to commute for cash. Indeed, before 2006 only annuities of less than 260 per annum could be trivially commuted. It may be beneficial to both the annuity provider and the annuitant to pay out any residual fund as a trivial commutation lump sum and for the annuity provider to cancel the original contract. Given the small income stream that such funds will be generating, the annuitant may find very few buyers (or no buyers) for their income stream, and the costs will be prohibitive. This approach would also tie-in with making freedoms consistent across time

6 Annuities purchased after 5 April 2015 From 6 April 2015 individuals were given complete freedom over how to shape their retirement, with no need to purchase an annuity regardless of the size of the pension fund. Therefore, it could be argued that anyone who purchases an annuity after this date has made a fully conscious choice. As these individuals were given full freedom, we believe that HMT should consider whether annuities purchased after 5 April 2015 should be barred from a secondary annuity market. Underwriting Non-Disclosure issues? There may need to be safeguards for those purchasing income streams. To obtain best value it will be in the annuitant's best interest to appear as healthy as possible with a long life expectancy. This could lead to non-disclosure or even fraud to inflate the price they receive. There may need to be a moratorium or another mechanism for purchasers to reclaim funds if the original annuitant subsequently died a lot earlier than the purchaser allowed for in the price and the loss is sufficiently large. Gender-based annuity rates Will any purchaser of a second-hand annuity be able to use gender-specific rates to value the income stream? After all, the purchaser is buying an investment rather than an insurance product. Nevertheless we would anticipate that, given recent EU rulings, this will probably not be allowed, making the market more valuable to males looking to sell their annuities on, but with purchasers looking to purchase annuities from females. If purchasers cannot use genderspecific rates, this could jeopardise the market owing to this dis-joint. Creating a secondary annuity market the proposed process The proposed process for the secondary annuity market is basically as follows: - 6 -

7 The re-assignment of the regular payments and the payment of the purchase price will need to be carefully co-ordinated. Some statutory safeguards may need to be in place such that the payment stream is assigned to the purchaser only once the annuitant has received 'cleared funds' from the secondary-market purchaser. Response to consultation questions Q1. In what circumstances do you think it would be appropriate to assign one's rights to their annuity income? It may be appropriate for an individual to sell on their annuity when their circumstances have changed. For example, they may now require long-term care, or they may have married or formed a civil partnership and now wish to provide for dependants that they did not plan for when they purchased their annuity. It may also be appropriate for an individual to be able to sell their annuity where their funds were too small to be used for drawdown and too large to be able to be trivially commuted at the time the annuity was purchased. It is not clear from the consultation whether dependants already in receipt of a pension can sell on their income stream. There may be a more appropriate need for these individuals to sell on their annuity income stream as they may not have made a conscious choice in choosing the income stream and are more likely to have changed circumstances

8 Q2. Do you agree with the government's proposed approach of allowing a wide range of corporate entities to purchase annuity income in order to allow a wide market to develop, while restricting retail investment due to the complexity of the product? What entities should be permitted and not permitted to purchase annuity income and why? We do support a wide range of entrants to the market to ensure competition and fair outcomes for all parties. Owing to the complex nature of the investment, we would support such a market not being open to retail investors. However, we would suggest that any legislation go further and prevent an entity that purchases a number of annuity income streams from packaging these up into products or funds that are open to retail investors. To prevent scams, whereby introducers who are not regulated act in conjunction with a purchaser (who is regulated) who transacts on an execution-only basis, any purchaser of secondary annuities should be regulated by the FCA and any introducers who introduce someone wishing to assign their annuity to a purchaser should be regulated by the FCA. Q3. Do you agree that the government should not allow annuity holders to access the value of their annuity by agreeing to terminate their annuity contract with their existing annuity provider ('buy back')? If you think 'buy back' should be permitted, how should the risks set out in Chapter 2 be managed? We do not agree that the exclusion of the issuing provider from buying back annuities is necessary or appropriate. The issuing provider may be able to provide better value than other third parties as they can factor in any administration cost savings they will be able to make by cancelling payments. In addition, there is nothing to stop a company selling the income stream back to the original annuity provider and the original annuity provider then cancelling the income stream. Such a process introduces additional costs over and above selling back to the original provider. We believe that the consumer protection argument does not hold up when the individual will be expected to take advice before selling on the annuity. Additionally, the original annuity provider may have used standard terms when impaired annuity rates should have been used so they could be in a stronger position to buy these income streams back. Moreover, we believe that a free and fair market should not be closed to certain participants. Q4. Do you agree that the solution to the death notification is best resolved by market participants? Is there more the Government should be doing to help address this issue? We agree that this issue will best be resolved by the market. There are a number of bureaux that currently provide mortality screening to the pensions industry that could be utilised by both issuers of annuities and those purchasing secondary annuities. One issue that is of concern is managing late notifications of death. We would anticipate a significant increase in late notifications of death where the original annuitant is not receiving the annuity income at the date of death

9 Q5. Do you agree with the proposed approach of the Government working with the FCA regarding the fees and charges imposed by annuity providers? We believe that the FCA and the Government should work together on the fees and charges. However we do not believe that fees and charges should be capped, but should instead be disclosed openly and explained in plain English so that the individual understands exactly what they are being charged for. It may be useful for the FCA to publish a standardised comparison table, in the same way that they publish annuity tables. Q6. Do you agree that the scope of this measure should be annuities in the name of the annuity holder and held outside an occupational scheme? We do not believe that the scope is fair or justifiable. Such discrimination gives rise to regulatory arbitrage that the Government has recently taken great steps to remove. Occupational pension schemes providing DC benefits should have the right to refuse the assignment of rights in the same fashion as annuity providers, but should not be excluded from the market. In addition, schemes should also be able to purchase the income stream back from the individual rather than the individual having to go out into the market. Section 32 policies that provide contracted out benefits will need to be excluded from the market. Under the definition as laid out, these would appear to be included, but we would suggest that the GMP rights being paid be statutory benefits and should not be able to be assigned. We would anticipate that there may also be a secondary market for DB pensions in payment at some time in the future, but this needs further consideration beyond the scope of this consultation. Q7. Are there any other types of products to which it would be appropriate for the Government to extend these reforms? We believe that individuals in receipt of an annuity held by an occupational scheme should also be allowed to sell these on for the reasons noted in our response to question 6. Q8. Do you agree that the design of the system outlined in Chapter 3 achieves parity between those who will be able to access their pension flexibly and those who will be able to access their annuity flexibly? Are there any other tax rules which the Government would need to apply to individuals who had assigned their annuity income? We do have some concerns listed below: How should the re-selling of an annuity purchased before 6 April 2006 be treated for Lifetime Allowance purposes? The funds would not have been tested against the LTA at crystallisation and will not have been tested against the LTA subsequently, unless specific events have occurred. Should the proceeds from the annuity resale be tested against the LTA? - 9 -

10 Should any proceeds in excess of the original annuity purchase price be taxed? For example, an individual aged 55, purchasing an annuity with no guarantee, no dependants' pension and no escalation would have received an annuity of approximately 5,500 in 2001 assuming interest rates of 4% and a fund of 100,000 (annuity rate of ). In 2015 with interest rates of 0.5%, the value of the annuity fund before commission and expenses on the same basis but, with the investor now aged 69, is still approximately 100,000 (annuity rate of ), but the individual has also had the benefit of 77,000 gross income from the annuity over the last 14 years. How is the consent of the annuity provider to work in the market? Does the original annuity provider have to consent to every sale or are they expected to provide blanket consent? If they have to consent to every sale, then how is this communicated to the company looking to purchase the annuity? Payments that continue after notification of a member's death are considered by HMRC to be unauthorised member payments. When the annuity has been sold on, how should payments that were paid to the secondary-market purchaser after a member's death (and before the original annuity provider was aware of the death) be treated? Q9. How should the government strike an appropriate balance between countering tax avoidance and allowing a market to develop? In theory, the easiest way to strike this balance will be by making the rules easy to understand and unambiguous to interpret. If transactions are managed as 'arm's-length' transactions with an independent adviser acting on behalf of the individual, this should help ensure that a market could develop for those who wish to sell their annuity, whilst countering any tax evasion see also our answer to Q10 about scammers. Q10. What consumer safeguards are appropriate is guidance sufficient or is a requirement to seek advice necessary? Should the safeguards vary depending on the value of the annuity? It is important that any individual looking to sell on their annuity takes independent advice. We believe that 'guidance' will not be sufficient. Selling an annuity will involve a number of complex factors. One other important safeguard is that annuity providers do not form an alliance with certain second-hand annuity purchasers that provide the annuity provider with preferential terms and the annuity provider then persuades their annuitants to use this purchaser. We believe that it will be as important for the FCA to ensure that annuitants are not encouraged by their annuity provider to use a particular firm, as it will be regulating charges and fees. Failure to monitor this could result in the annuitant being misdirected twice - once on the original annuity purchase (if they were not adequately informed of the open-market option) and again when selling on their annuity

11 It will be difficult to vary the requirement for advice according to the value of the annuity, as valuing the annuity is the hardest part of the process and different companies will place different values on the annuity. One option would be to value the annuity on an agreed standard actuarial basis such as used in Statutory Money Purchase Illustrations. Where the individual was forced into purchasing an annuity with a small pot, it may be better to allow trivial commutation if the provider will not or cannot offer this, then we believe that the annuity provider should allow the individual to sell their annuity. One safeguard that may provide comfort for providers, individuals and government alike is a minimum income guarantee. If the individual can prove that they have guaranteed income, perhaps 15,000 per annum, from other sources (other pensions including state pensions, investments and so on), then they should be allowed to sell the annuity on. We have significant concern that annuitants could fall into the hands of scammers, especially as older people are potentially more vulnerable to scams. See also our comments in the answer to Q2 about secondary annuity providers (and introducers) being FCA-registered. Q11. What is the best way to implement these safeguards? Should the safeguards include expansion of the remit of Pension Wise? Owing to the complex nature of annuities and factors involved in selling an annuity, we believe that it would not be appropriate for individuals to take just guidance on whether to sell their annuity unless the annuity is very small and there are advantages to both the annuitant and the annuity provider to cancel the annuity and make a cash payment to the annuitant. Pension Wise could have its remit extended to provide guidance to annuitants that are considering selling on their annuity on the understanding that Pension Wise only offer guidance and the annuitant would need to take regulated independent advice if they wished to go to the next step. After the Pension Wise guidance some annuitants may decide not to proceed and would not need to take regulated independent advice. Otherwise, it would be appropriate for the Government to expect individuals to take advice from a suitably qualified and regulated independent adviser on whether to sell their annuity and for the adviser to be required to obtain best value, should the individual decide to sell their annuity. Owing to the complex nature of such decisions, advisers involved in selling annuities should be required to be qualified to at least the same level as advisers on DB to DC transfers. As indicated above, one proviso where guidance through Pension Wise may be appropriate is if, instead of selling the annuity on, the annuitant can surrender the annuity back as under current rules the fund would have qualified for trivial commutation. The annuitant should be made aware of the risks involved in such a transaction including the impact on means-tested welfare benefits, social care support and council tax reductions. Such a two-tier approach would then frame the selling of annuities in the same legislative framework as a DB-to-DC transfer where advice is not required for transfers of less than 30,000. This should be allowed only where the original fund used to purchase the annuity was 30,000 or less; simplifying the task for the individual of identifying whether their annuity qualifies

12 Q12. Should the costs of any advice or guidance be borne by the annuity holder (mirroring the arrangements for conversion from a defined benefit scheme)? If not, what arrangements are appropriate? The costs of advice should typically be borne by the annuitant when seeking advice on whether to sell on their annuity. Q13. Do you agree that the Government should introduce a requirement on individuals to obtain a number of quotes? How else should the Government best promote effective competition to ensure consumers obtain a competitive price? It may be difficult to force individuals to obtain a number of quotes for a number of reasons: for example, companies may not be willing to quote for an individual or the number of companies in the market may be temporarily or permanently less than the required number of quotes an individual is expected to obtain. Instead, it would be best that individuals are required to take advice from an FCA-regulated adviser, with the adviser expected to obtain best value for the individual and 'sign off' the sale. Q14. Does the Government's approach sufficiently protect the rights of dependants upon assignment? If not, what further steps should the Government take? Should the Government or FCA issue guidance to annuity providers about protection for dependants? Are there particular classes of beneficiary which require special consideration, for example, minors or following a divorce or dissolution of a civil partnership? Are there specific equality impacts that should be considered in this context? We believe that the FCA should issue rules/guidance to annuity providers and secondarymarket purchasers about the secondary annuity market, including protection for dependants. Care may have to be taken where the dependant is not able to enter into a contract, such as minors and those not of a sufficient mental capacity. Q15. Should the Government permit the principal annuity holder's income to be assigned while dependants retain their own income stream? Should the decision on whether to do so be left to the discretion of the parties to the transaction? We believe that this should be up to the parties involved in the transaction, including the original annuity provider. The original annuity provider may want to only deal with one party from the point the annuity is sold. If a dependant's income stream is sold on, then the new purchaser should continue to receive an income stream until the relevant termination event for the dependant. In such circumstances, we would expect legislation to be laid that requires the dependant to sign off on the deal. Legal protection may be required where the dependant cannot enter into a contract, either due to age or incapacity

13 Q16. How can the proposed consumer protections for the assignment of annuities ensure that any impact on means-tested entitlement is understood by those deciding whether to assign their annuity income? We would suggest that the same protections that have been put in place for the new pension freedoms should be applied to anyone looking to sell their annuity. The same delivery mechanisms for the guidance on deprivation of assets could apply; it could be argued that, since this is an extension of those freedoms to annuitants, it should be the same method and guidance. We believe there are still uncertainties about the impact on such means-tested benefits related to the pension freedoms. Given that the secondary annuity market will involve individuals reducing their current income, it is even more important that the guidance be very clear and appropriate for the age of the relevant consumers. Q17. Should those on means-tested benefits be able to assign their annuity income? This would depend on the type of means-tested benefits payable. If the benefits are means-tested retirement benefits, then there are valid arguments for not allowing them to assign their annuity income, as this will only increase their dependency on the State. However, if the benefits relate to carer's allowance or disability benefits, then the Government will need to be careful that such exclusion fits with equality impacts and is not considered discriminatory. In addition, it may be that the annuity income is a small amount in comparison to the means-tested benefits they are in receipt of and selling the annuity may not impact significantly on the level of benefits they receive. A further consideration is how to treat individuals who, by assigning their annuity income, could then qualify for means-tested benefits. Should they be disqualified from claiming means-tested benefits if they assign their income? If they are to be treated equally with individuals under the new pension freedoms, then they should be treated as if they had never assigned the income and refused any additional benefits. It may be that annuities can be resold only if the individual can prove that they have additional income from other sources that meets a guaranteed minimum income. Q18. What are the likely impacts of the Government's proposals on groups with protected characteristics? Please provide any examples, case studies, research or other types of evidence to support your views. We have no comment on this question. Other considerations on a secondary annuity market Secondary-market purchasers will need to know whether any part of the payment stream has been earmarked or is subject to some other lien (such as a bankruptcy order) that could prevent the sale. Potentially they will become aware of this only when requesting details from the current annuity provider

14 Where the annuity is subject to such liens, then the annuitant should not be able to sell on the annuity. Conversely, we believe that it should not be possible to force individuals into selling their annuity, should they become bankrupt, or if there are other third parties wanting to lay claim to their assets. We would advocate a cooling-off period be put in place to allow individuals to cancel their decision to sell their annuity, although care will have to be taken to design this in the event that income has been paid to the purchaser in the intervening period. On re-assigning the annuity to a third party, the original annuity provider will incur transactional and ongoing administration costs, but it is not clear how these can be recouped. The purchaser provides funds to the individual (or a provider of their choice) leaving the original provider out of the loop. Therefore the only way that costs can be covered is to load new annuities for additional administration costs, creating a vicious circle for annuities, with these products looking even worse in comparison to other retirement options. A method that could work would be for there to be a mechanism that will allow the original annuity provider to take a portion of the resale value to cover reasonable ongoing administration costs. This level of costs may need to be set and monitored by the FCA, although care will have to be taken that this is not too low, or the annuity provider will simply veto any attempts to sell the annuity on. It is not clear from the consultation whether individuals could go against any guidance or advice and sell their annuity on. What safeguards should purchasers put in place to ensure that individuals have at least received advice? We would suggest that safeguards similar to those in place for DB to DC transfers be put in place for purchasers of annuities. In conclusion We welcome the opportunity to respond to HM Treasury's consultation on creating a secondary annuity market. We believe that developing a secondary annuity market could create good outcomes for some consumers, especially those who were forced to buy a small annuity before the trivial commutation limit was increased to 30,000 in March However, we believe there are significant risks of consumer detriment and significant costs that consumers will have to bear. The process will be complex and difficult for some consumers to understand, so there is a need for independent advice in most circumstances. We would be more than happy to be involved in discussions with HM Treasury, DWP and FCA representatives to discuss any points raised in our response if that would be helpful. Jerry Barnfield Group Head of Market and Product Strategy aquilaheywood Luke Carter Product Consultant aquilaheywood 16 June

15 Appendix - about aquilaheywood and our clients aquilaheywood, the Group comprising aquila and heywood, is the leading supplier of life and pensions administration software solutions in the UK. The pension schemes for ten million members in more than 200 major organisations are run using our administration software solutions. These solutions cover the whole range of available schemes including DB, DC, hybrid, career average, cash balance and stakeholder, as well as a full range of other group and individual products including Group Risk, Individual Protection, SIPPs and Wraps, Income Drawdown and Annuities. The Group provides solutions across a diverse range of markets including Financial Services, Third-Party Administration, Corporate and Public Sector pension schemes in the UK, Ireland and the rest of Europe. Its clients include Aviva, Fidelity, Irish Life, Scottish Widows, British Airways, BBC, ASDA, Diageo, Tesco, Aon Hewitt and most local authority schemes. We also provide software and services in to Central Government schemes in Scotland and Northern Ireland

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