Defined benefit plans could buy up annuities on the secondary market to match changes in long-term interest rates and longevity, said pension fund consultant Lane Clark & Peacock.
The potential for pension funds to buy annuities on the secondary market follows a consultation by the U.K. government into whether participants in defined contribution plans should be allowed to sell their annuity policies. The consultation follows other changes to the U.K. retirement plan market, with reforms implemented in April that no longer require a DC participant to purchase an annuity to provide income in retirement.
In its latest investment views publication, LCP partner Adam Michaels said the cost to DB plans of having to pay members for longer “should be partially offset by the annuities bought continuing to pay out for longer.”
Mr. Michaels wrote a portfolio of secondary annuities could be held to match pension liabilities, but he warned that they were not a perfect match. Secondary annuities would reflect only how long other people live, as opposed to a buy-in arrangement, which is tailored to members. “So second-hand annuities will need to be cheaper than buy-ins to compensate buyers for this risk, and also to cover costs such as medical underwriting. The big unknown is whether enough sellers will feel that they are also getting a good deal at such prices,” he wrote.
There are other challenges. Annuitants would need to be protected from making the wrong decision to sell, and buyers would need to be “protected from terminally ill annuitants, say, not being completely honest about their condition,” Mr. Michaels said.
The size of the market might be a challenge. Mr. Michaels said that with around 5 million people owning an annuity, “my bet is that a good proportion of these would be interested in selling … lots of people would rather have cash in hand than a regular income, to spend on a cruise or a new conservatory.” He said low bond yields might also mean that sellers could be offered “a sizable sum to cash in their policy.”
The publication can be found on LCP’s website.