Annuities to become more flexible

Retirees will soon have a new option to improve their pension income with the launch of the first annuity allowing individuals to upgrade to a better rate if they fall ill.

This enhanced-rate conversion facility will break new ground as, at present, the bulk of retirees find themselves locked into inflexible pension contracts that take no account of their declining health.

Under the terms of these “next generation” annuities, retirees whose health worsens will be able to break their contract and convert to an enhanced rate for impaired lives – which can boost their pension income by an average of 20-25 per cent.

“One in two customers who are in good health at 65 won’t be in good health by the time they get to 75,” explains Stephen Lowe, spokesman for Just Retirement, the pension provider launching the conversion feature.

“However, with this unique feature, the customer will not have to wait until the end of the term to get access to the benefits available.”

Just Retirement says that the innovation – offered on its fixed-term annuities (see below), but not on conventional lifetime annuity products – will be of benefit to vast numbers of retirees suffering from light to serious health impairments.

It gives the example of a 65-year-old male who began to suffer a range of medical problems after taking out a ten-year fixed-term annuity, which had given him an income of £3,041 in return for his £50,000 pension fund.

Since taking out his enhanced annuity, the man was diagnosed with angina, had bypass surgery and began taking prescribed medication for his condition.

A conventional annuity would not make any allowances for the decline in his life expectancy by improving his income.

But, with the conversion feature, the man could ask for his income to be re-assessed on enhanced terms, resulting in an income boost of £700 a year. If the man had been diagnosed with bowel cancer, with lymph node involvement, and he required chemotherapy and surgery, he could convert to an enhanced rate which would boost his annual income of £900.

“A lot can happen between the ages of 68 and 70,” says Lowe. “The client’s income can improve based on the new state of health.”

Just Retirement says clients who decide to convert will be given a quote for its own enhanced annuity, but also an ‘open market option’ valuation, so they can shop around to make sure they are getting the best rate on the market.

“Overall, I think this seems to be an innovative product which will help add an extra layer of flexibility to the annuity market,” says Alex Edmans of Saga, the specialist financial adviser for the over-50s. “However, the devil will be in the detail and the costs required to add the additional flexibility.”

Just Retirement says it will not impose surrender charges if an annuitant opts to convert to an enhanced rate. However, those who do convert will lose the guarantee of getting back a fixed lump sum at the end of the fixed-term annuity. So there is a risk that they will have less money available when the fixed-term annuity ends.

“The client needs to be aware that the value of the fund they receive will be the value of the underlying assets which will be a bond portfolio,” says Bob Bullivant, chief executive of Annuity Direct.

“If interest rates were to rise, the value would be lower, but this might be offset by a rise in annuity rates. The key point is that this is an option and the client can continue until the end of the selected term if they wish.”

Just Retirement is only making the feature available to clients who opt for ‘Plan Protection’ on their annuities, which enables capital, minus income payments, to pass to a beneficiary if the member dies before the end of the fixed term contract. This protection will reduce the starting level of income by 3-7 per cent.

Advisers say the enhanced opt-out feature may become a standard feature in the fixed term annuity market, but won’t readily apply to conventional lifetime annuities, which are priced on a different basis.

Living Time and Canada Life also sell fixed-term annuities – and Aviva, the biggest insurer in the UK, is set to enter the market soon.

What are fixed-term annuities?

Fixed-term annuities, also known as ‘short-term’ or ‘temporary’ annuities, offer the benefits of a guaranteed income over an agreed period of time, typically five to ten years, with a guaranteed maturity amount (GMA) at the end of the term. This GMA can be reinvested as the individual sees fit. These annuities are an alternative to the conventional lifetime annuity and appeal to individuals who want the flexibility to change their income to suit changes in their circumstances – such as the death of a spouse or a decline in their health. However, there is a big risk that, by the end of the fixed term, annuity rates will have fallen, meaning a reduced income in future. A technical quirk means that fixed-term annuities are arranged under the income drawdown rules, for pensions – but, for all intents and purposes, they are annuities as the income is secure and the individual does not bear investment risk.