Impact case study database

The UK’s annuity market is still one of the largest in the world, currently valued at GBP3 billion per year, even after the pension freedoms introduced in 2015. Almost half a million individuals or couples retire each year and, in 2017/18, 10.4 million individuals had a DC pension in the UK (Source: HMRC, Sept. 2019). In 2018/19, 645,000 pension plans worth GBP39.7 billion were accessed to convert into a retirement income product (annuity, drawdown or first cash withdrawal: Source: FCA, Sept 2019).

C&T’s established reputations as world experts in annuity markets has led to the extensive use of their research to shape policymakers’ understanding of the annuities market and inform a breadth of policy discussions – in the EU as well as the UK, by both government and regulators, and across the political spectrum. Their research, in turn, benefits pension providers and retirees by providing policymakers with the insights needed to help ensure that pension systems are stable, fairly priced for pensioners and can honour annuity payments to pensioners despite risks to retirement incomes.

1. Informing EU policy discussions: cross-European decumulation policies and value-for money-issues

In 2016, the EU Directorate General for Financial Stability, Financial Services and Capital Markets Union (DG FISMA) launched a study on the performance and adequacy of pension decumulation practices (the process of converting pension savings to retirement income) in EU countries, conducted by the external consultant Ernst & Young Actuaires-Conseils. The resulting report (I5.1) extensively cites C&T’s research, on nine occasions in total, demonstrating the core value of C&T’s work to policy discussions. Specifically, the report draws on their work into compulsory and voluntary annuity markets in the UK (R3.2), money’s worth of life annuities (R3.3) and annuity markets in the Netherlands (R3.4/R3.5). It highlights key issues in relation to fair pricing, appropriate life tables and the amount of reserves that insurance companies hold to make guaranteed annuity payments to pensioners.

A testimonial from a Consultant at Ernst & Young states “ Our work on decumulation pension practices in the UK and the Netherlands is based to a great extent on the above published papers written by Professors Cannon and Tonks. . . . The work of Professors Cannon and Tonks has enabled us to identify issues in annuity markets… and their data has been most useful in enabling us to calculate money's worth ratios of decumulation products” (I5.1).

1. Informing UK policy debates

a. UK financial market regulation: Value-for-money issues FSA and FCA papers and consultation

C&T’s work has been widely used by UK financial regulators to improve their understanding of annuity markets, in particular, of how the markets operate, whether annuities offer value-for-money and the implications of abolishing compulsory annuities. More specifically:

• In 2013, the Financial Services Authority (FSA) commissioned C&T to review and advise on the FSA’s annuities research into the workings of the annuities market. Some of this work was subsequently published in the FSA Thematic Review of Annuities, TR14/2 (2014); and in the Financial Conduct Authority (FCA) Retirement income market study (2015).

• A report for the FCA by Wells (2014) cited the work of C&T from the perspective of consumer behaviour towards annuity purchases. The Financial Services Consumer Panel cited C&T’s work in November 2014 on whether annuities offer good value-for-money (Pitt-Watson et al, 2014) and the implications for costs of providing annuities. This research, in turn, was cited by the FSA/DWP in their March 2015 Consultation Paper on disclosure of transaction costs in workplace pensions (page 16) (I5.3).

• In March 2014, the FCA invited C&T to submit a response to the FCA Consultation on Retirement Income. Following the changes to the compulsory annuitisation requirements announced in March 2014, they were invited again to submit a response to the Revised FCA Consultation in July 2014 (I5.4).

• An FCA occasional paper (Aquilina, Baker and Majer, 2014) on annuities’ value-for-money (I5.5) cited C&T’s work on annuities 18 times. It drew heavily on their money’s worth research (R3.3), in particular the evidence on the fall in in value-for-money of annuities since 2004. This paper was used as the basis for the FCA “Retirement Income Market Study” in March 2015 (see footnote 3 page 7) and annual updates which identified areas in which the annuity market was not functioning well (I5.5). This is an ongoing area of research for the FCA. A testimonial from a Technical Specialist at the FCA confirms that C&T’s research “ has been very influential” within the FCA, and that the findings of the occasional paper, which followed C&T’s methodologies, were “ then used by the FCA to design policy interventions in the pension sector” (I5.5).

b. UK government policy: Solvency-2 regulations and capital requirements for prudential regulation

In the summer of 2018, HM Treasury commissioned C&T to write a confidential assessment of the UK Annuity Market (I5.6). The report, published August 2019, was in the context of the EU-wide Solvency-2’s regulatory requirements for life insurance companies (introduced in 2016) and also the consequences of the pensions freedoms (abolition of compulsory markets) from 2014, and built on the research on insurance market prudential regulations (R3.3). The Solvency-2 regulations are designed to ensure that insurance companies manage their money responsibly in order to fulfil their annuity promises, i.e. it is invested wisely and pensioners can continue to receive payments over several decades, until death. Of particular concern for HM Treasury was the fair pricing of the schemes – not too expensive for pension holders, nor too cheap to undermine the long-term viability of the provider and its ability to make pension payments: the trade-off identified and quantified in C&T (R3.3). This report’s development involved a series of six meetings in 2018 with C&T in attendance with representatives from the Cabinet Office, HM Treasury, FCA, the Association of British Insurers, and the Bank of England.

This research has helped HM Treasury understand the impact of Solvency-2 and the pension freedoms on UK annuity markets and has been used in the following ways:

• As part of a briefing prepared for HM Treasury Ministers in preparation for their appearance in front of the Select Committees;

• As part of an internal briefings for HM Treasury Ministers and senior managers on the annuity market;

• As part of the evidence base drawn upon in formulating HM Treasury’s strategy on the regulatory framework and design of policy for life insurers in a post-Brexit world.

According to a testimonial from the Head of Prudential Regulation of Insurance Companies, HM Treasury, “ The final report was excellent – thorough and clear … has been used by HM Treasury to understand the impact of Solvency 2 and the pension freedoms on UK annuity markets, specifically, it will be used to inform the appropriate prudential regulatory framework for the insurance sector, and particularly the life insurance sector, to apply from 1 January 2021” (I5.7).

c. Labour Party-commissioned IRRI study

In 2014, Rachel Reeves MP, then Labour Party’s Work and Pensions Secretary, commissioned The Pensions Institute to conduct a two-year study to look at how to boost defined contribution (DC) savers’ retirement income following the introduction of the Coalition Government’s ‘freedom and choice’ pension reforms announced in the 2014 Budget. The final Independent Review of Retirement Income (IRRI) (I5.8), published March 2016, cites C&T’s annuities research 12 times, and in Recommendation 2.5, specifically recommends that the regulator use their money’s worth metric, and provide transparent charges (recommendation 2.6) that the customer can use alongside with the money’s worth calculation. This, again, demonstrates the fundamental value of C&T’s research to key policy questions regarding annuities, and for policymakers across the political spectrum.