How are Annuity Rates calculated?
If you have been shopping for an annuity you maybe wondering why there is such a big difference in the rates offered from different annuity providers. Here we discuss the reasons why there can be differences and why it is important to shop around when buying an annuity.
Gilt Yields
This is the single biggest factor that impacts on annuity rates as this is what insurance companies use to invest your pension fund in when you buy an annuity. Because gilt yields are seen a secure and low risk investment they the best way for insurers to ensure they meet their payment obligations when offering annuities. However because gilts are seen as a safe bet for investors they have become increasingly popular throughout the credit crunch, as investors look for a safe place to invest their capital. A consequence of UK bonds becoming more popular is that the price has risen which in turn puts downward press on the yield (return). A lower yield means a lower return for insurance companies which means less money to offer retirees in terms of annuities. Their popularity has been further boosted by the sovereign debt crisis in Europe, which has seen investors turn away from Eurozone countries, as well as the governments policy of printing money known as Quantitative Easing.
Mortality rates
This in a nutshell is the measurement of death within a country’s population. These have been falling as life expectancy has been rising due to advances in medical science and better eating/lifestyle habits. Looking at this chart you can see how life expectancy has risen over the last 40 years and is expected to rise further. It is thought that around 10% of people born today could live pass the age of 100, which means if they retired at 65 they would have a 35 year retirement. As there are more and more retirees living for an increasing number of years, so annuity providers have to adjust rates accordingly. The provider will try to calculate your life expectancy based on your age and if done properly your current state of health.
Competition in the Market
As with most insurance products there are a number of different companies vying for new businesses. At a time when credit is at a premium, a pensions fund is an attractive acquisitions for an insurance company. Each month you can check out annuity rates tables showing you a snapshot of current annuity rates, but only from the providers who disclose their rates (not all of them do). Although one provider may have the best level rates, this may not be the best deal as there are, for example, specialist enhanced providers who could increase your annuity offer substantially.
State of Health
Your current state of health should (if assessed properly by an adviser) be an important factor taken into consideration when buying an annuity. Those retirees with a medical condition or lifestyle choice which may impact upon their life expectancy (such as smoking and drinking) are often offered better, enhanced annuity rates. There are over 5,000 different conditions which can qualify a person for enhancements and it is estimated that up to 7 out of 10 annuitants are eligible for an enhanced annuity in some form. If you have a serious medical condition then you could be eligible for an impaired life annuity, which could boost your rate by 40% or more compared with a standard annuity.
Partner / Spouse
If you opt for a joint-life annuity, where once you pass away your annuity income is (full or partially) passed onto a dependent, then you can expect a lower annuity rate. This is because the risk for the insurance company is higher. Annuities have sometimes attracted criticism because if the annuitant passes away prematurely and they did not take a joint-life annuity, then the remaining fund is kept by the annuity provider. This is another reason why it is so important to get proper advice because some providers will not make you aware of this danger and will gladly sell you a bog standard level, single life annuity. If you don’t want to opt for a joint-life annuity you have the option to factor in guarantee periods. These allow you to state a specific time period after the date of purchase, such as 5 - 10 years, whereby you can guarantee that your annuity income will continue to be paid to your partner or spouse.
Escalations
The most popular annuity is a standard, level annuity which pays the same amount each year until death, regardless of how long you live. However with inflation climbing year on year in real terms your spending power is reduced which is why some retirees like to build in escalations. This can either be linked to the Retail Prices Index which is the standard measure of inflation, or this can be pre-determined percentages such as 1%,2% etc. This isn’t extra money it is just deferring income as your starting amount is lower compared to a level annuity.
Postcodes
As with other forms of insurance, where you live can have an impact on the rates you are offered. This is because people in more affluent areas on average live for longer than those who live in less prosperous parts of the country. For example the difference in average life expectancy for a man living in the east of Glasgow compared to West London can be as high as 13 years. Retirees in more affluent areas are a higher risk for insurers as they are likely (based on statistics) to live for longer.
