1. Effect of Reforms to Compulsion on Annuity Demand Edmund Cannon (University of Bristol) Ian Tonks (University of Bath) and Rob Yuille (ABI) Presentation at NIESR Conference on Future of Pensions, 11 th December 2015

2. The big picture: removal of CA Policy objective “supporting savers” – “With the right consumer guidance, advice and support, people should be able to make their own choices about how to finance their retirement. Everybody’s circumstances are unique and it should not be for the State to dictate how someone should have to spend their savings” (Para. 1.7, HM Treasury March 2014) Pros and cons of compulsory annuitisation: Protects state against moral hazard & individuals against myopia Reduces (adverse) selection problems: ensures efficient large market Reflects tax advantages given to pensions – BUT Redistributes wealth away from poor (short-livers) to rich (long-livers) Inflexible: – eg. prevents individuals bequeathing pension wealth

3. Regulatory time-line A-day: April Normal Min. Pension Age=50 Relax CompAnn Announce June Relax CompAnn Announce June Abolish CompAnn Announce March Relax CompAnn Implement March Abolish CompAnn Implement March RDR: Jan Abolish Contracting Out April Gender neutral Dec Normal Min. Pension Age=55 April

4. Relaxation (2010) and Removal (2014) of compulsory annuitisation Prior to reforms: compulsory annuitisation at age 75 Relaxation in 15 th July 2010 Consultation Implemented April 2011 – Three choices at retirement: Annuity; Capped drawdown (max withdrawal: 100% annuity rate); and Flexible drawdown: subject to MIR (£20,000) Removal announced 19 th March 2014 Implemented after 6th April 2015 – Three choices (+ free guidance): Annuity Drawdown (?) Cash withdrawals subject to marginal tax rates from age 55 – Transitional regime for 2014/15 More flexible drawdown; small pots/trivial commutation

5. Research questions What has been the effect of both the 2011 and 2014 reforms on: Sales of annuities & drawdown products? Size distribution of annuity sales – Predict: increased limits on trivial commutation affected the lower end of the annuity market more Age distribution of annuity sales – Predict: More sensitivity to reforms at younger ages Different types of annuity product? Financial advice/guidance – Predict: Effect of the RDR to cause financial advice to be concentrated on larger pension pots

6. Data 2007:Q1-2015:Q3 Data provided by ABI from quarterly survey of ABI data providers Quarterly annuity and income drawdown sales aggregated across providers, by Product type Internal/external Age of recipient Size of purchase Financial advice

7. Quarterly Sales of Annuities/Drawdown Panel A: # Contracts (000s)Panel B: Value of sales (£m)

8. Average Size of Annity/Drawdown Contracts Increase in size of annuity purchase Decline in size of drawdown purchase

9. Estimates (1)(2)(3)(4)(5)(6) Annuities: no of contracts (thou) Drawdown: no of contracts (thou) Annuities: total premiums £m Drawdown: total premiums £m Annuities: average premium £'000 Drawdown: average premium £'000 Constant111 *** 7.11 *** 2,770 *** 576 *** 25 *** 80.4 *** (2.41)(.638)(74.3)(43.8)(.875)(2.08) Policy change 2011q2 -14.9 *** -2.22 * 308 * -213 ** 7.06 *** -7 * (3.75)(.992)(116)(68)(1.36)(3.24) Policy announce 2014q2 -66.9 *** 9.87 *** -1,808 *** 651 *** 13.4 *** -3.06 (4.98)(1.32)(153)(90.2)(1.8)(4.3) N35 r2.904.643.822.62.818.202 Standard errors in parentheses * p < 0.05, ** p < 0.01, *** p < 0.001

10. Distribution of Annuity Sales by Size of Annuity Purchase Fall in annuity sales Particularly for small pots

11. Estimates of ln(# annuity sales) by size (1)(2)(3)(4)(5) < £5,000 £5,000 to £39,999 £40,000 to £99,999 £100,000 to £249,999 £250,000 and above Constant10.6 *** 10.8 *** 9.62 *** 8.28 *** 11.6 *** (.103)(.0699)(.0518)(.0543)(.0675) Policy change 2011q2 -.382 * -.147.201 **.237 ** -.152 (.137)(.0925)(.0685)(.0718)(.0893) -32%-14%22%27%-14% Policy announce 2014q2 -1.66 *** -1.28 *** -.928 *** -.716 *** -1.22 *** (.155)(.105)(.0776)(.0814)(.101) -81%-72%-60%-51%-70% N27 r2.876.89.859.763.889 Dependent variable is the log of the number of policies purchased. Standard errors in parentheses * p < 0.05, ** p < 0.01, *** p < 0.001 Figures in red approximately convert the regression coefficients to percentage falls (= exp(betahat) - 1).

12. Percentage Distribution of Annuity Sales by Age Peaks in annuity purchases at 60 & 65 Relative decline in annuitising at younger ages Panel A: Panel B:

13. Estimates of ln(# annuity sales) by age (1)(2)(3)(4) Age 55Age 60Age 65Age 70 Constant1.43 *** 2.9 *** 3.06 ***.161 (.108)(.0688)(.0636)(.108) Policy change 2011q2.308 * -.282 **.114.283 (.143)(.0911)(.0842)(.143) 36%-25%12%33% Policy announce 2014q2 -1.17 *** -1.33 *** -1.04 *** -1.06 *** (.162)(.103)(.0954)(.163) -69%-74%-65% N27 r2.686.909.843.642 Standard errors in parentheses * p < 0.05, ** p < 0.01, *** p < 0.001 Dependent variable is logarithm number of policies purchased. Dependent variable is logarithm number of policies purchased. Standard errors in parentheses. * p < 0.05, ** p < 0.01, *** p < 0.001 Figures in red approximately convert the regression coefficients to percentage falls (= exp(betahat) - 1).

14. Effect of Min. Age Rules on Annuitisation

15. Proportions of annuitants & drawdown recipients using financial advice Decline in purchases via IFAs of both annuities & drawdown

16. Summary impact of abolishing CA on annuity market Large fall in purchase of annuities from peak of (annualised) nearly £16 billion in 2012 to nearly £5 billion Increased use of drawdown – Increase in size of annuity purchase – Decline in size of drawdown purchase Larger annuity pot sizes: – small amounts taken as cash # annuities purchased <£5,000 fell by – 32 per cent after the 2011 change and – further 81 per cent after the 2014 announcement Peaks in annuity purchases at 60 & 65 – Relative decline in annuitising at younger ages Decline in purchases via IFAs of both annuities & drawdown

17. If no annuitisation: Optimal decumulation strategy? Highly complex, depends on eg – Anticipated investment returns & longevity prognosis – Drivers e.g. bequests, long-term care provisions – Attitude to risk, behavioural finance & costs Defer annuitisation; but optimal to annuitise around age 80 for males: – Drawdown may be best if risk aversion low or desire to bequeath – But growth asset exposure needed to offset mortality drag Cognitive problems of elderly: – FSA (2006) survey of financial capability found over-70s performed worst of all age groups – Dementia risk doubles every five years after age 60 Need for Financial Advice

18. Conclusions Reforms have led to a significant decline in sales of annuities Drawdown sales have increased Future trends uncertain as the market settles Main effects at small-pots end of market – Increase in size of average annuity purchase increase – Decrease in size of drawdown purchase What is appropriate decumulation strategy for pension wealth? For many annuitisation remains best alternative – Nudge policies?