Healthy individuals face shrinking pension incomes as the increased popularity of enhanced annuities, which offer better deals to people likely to die younger, is piling further pressure on to already low standard rates.
Rates on standard annuities – which pay a set annual income for the remainder of your life in return for payment of a lump sum – have been squeezed by increasing life expectancy and low interest rates. They are now likely to sink even further as individuals with lower life expectancies, such as smokers, diabetics and obese people, are fleeing the traditional market in hunt of better deals from specialist enhanced annuity providers.
Enhanced annuities provide a higher rate of income as providers work on the basis that they will be paying out for a shorter length of time. They work along the same lines as impaired life annuities, which target people with severe medical conditions such as cancer, although enhanced rates can simply be aimed at people with unhealthy lifestyles.
Providers say people who qualify for an enhanced annuity could gain up to 20 per cent more income per year, compared with the best rates on standard annuities.
Standard rates have traditionally been calculated using a cross-section of risk, so people who die earlier effectively subsidise those who live longer. The concern is that without the extra capital from less healthy people who die before they have used up their full pension fund, annuity providers will have to lower the rates for people who do not qualify for an enhanced deal.
Stuart Bayliss, director of Annuities Direct, says annuity providers are increasingly assuming that most of the people who qualify for enhanced rates are taking them. They are therefore cutting rates for those who remain in the “standard rates pool”.
“If someone qualifies for an enhanced rate but has remained on a standard rate then they are missing out on a better deal and effectively paying a premium for doing so,” says Bayliss. “With pressure already on rates people may as well get the best deal they can at retirement.”
The best standard annuity rate for a healthy 65-year-old male is now around 7.1 per cent. Five years ago it was 8.6 per cent. Rates are also in danger of becoming even less competitive as A-day pension changes have given people with pensions of £15,000 or less (for this tax year) the ability to take their entire pot as a cash lump sum. This may hurt standard annuities as people with smaller pension pots tend to have shorter life expectancies.
According to the latest figures from the Association of British Insurers, people with enhanced or impaired annuities account for around 10 per cent of the market. But annuity providers believe that up to 40 per cent of people taking out annuities could actually qualify for a better rate.
Bayliss says that while five years ago a smoker might have got 5 or 6 per cent more than the best rate for a non-smoker, now they could get a premium of up to 15 per cent. People with other conditions, such as high-blood pressure or emphysema, could get an even higher income.
Just Retirement, which underwrites around half of the enhanced and impaired annuity market, says the number of conditions or ailments that could grant someone access to an enhanced rate has risen by around 50 per cent to 1,500 over the past year. They now include conditions such as hypertension, lung complaints and high cholesterol.
Also, the number of enhanced annuity providers is growing. Many niche providers have sprung up, while large insurance groups such as Legal and General and Prudential have entered the market and Scottish Equitable is planning to do so soon.
Nigel Barlow, technical and commercial manager at Just Retirement, says the current low take-up of enhanced annuities reflects a lack of awareness, and also the fact that people can be reticent about discussing their own illnesses.
“Going down the route of enhanced or impaired annuities really brings home the fact that they might not have long to live,” he says.
Also, the idea of getting a better deal if you are unhealthy is the total reversal of what people are used to before retirement, when applying for life or medical insurance. Providers say people may not realise that the fact that they smoke or are overweight, can in the case of annuities, help them get more money.
A large proportion of people who have saved for a pension automatically take their annuity from their pension provider for ease, or because they are unaware that they have the option of taking their money elsewhere.
According to recent research by the ABI, only around a third of people shop around when taking an annuity.
If you think you might qualify for an enhanced annuity speak to your financial adviser or a specialist annuity provider. Typically you will be asked to fill in a medical questionnaire but you will probably not be required to undergo a full medical examination.
