Annuity guarantees evaporate under pressure

Low gilt yields are having an alarming impact on new pensioners. Andrew Verity reports

FOR Dr David Abrams, a 70-year-old from Hammersmith, the financial collapse in Russia and the Far East is not just an interesting news story from distant countries. Russia's rouble trouble has hit him right where it hurts - in his pocket.

Dr Abrams is no big investor. He is simply one of tens of thousands of people looking to retire in the near future, when he will swap his pension fund for an annuity, an income until death from his insurance company. The trouble is that what the insurance company pays depends on what it costs them to finance the annuity. That depends on the yield of 15-year gilts: the higher the yield, the more the insurance company can afford to pay.

Here is the link: the rouble crisis has shaken confidence in shares to such an extent that huge amounts of money have flown into the safer kinds of investment - especially government gilts. That has forced up their price. As the price goes up, the yield goes down. Result: record low annuity incomes.

People retiring now are doing so at the worst time. Annuities are at an all-time low and the pension funds used to buy them, made up largely of shares, have fallen in value. Someone who retired six months ago with the same savings would be substantially better off.

But what makes Dr Abrams particularly unhappy is the behaviour of his pension provider, Equitable Life. In the early 1970s, dozens of insurance companies promised to give customers an annuity rate. The nature of the guarantees varied, but typically they promised at least pounds 1 of income for every pounds 9 they had saved.

For the insurers, it seemed like a safe bet. In the 1970s, gilt yields and annuities paid out at least pounds 130 for every pounds 1,000 of pension saved. Insurance companies can now only pay around pounds 94 for every pounds 1,000 of pension. If they have to pay pounds 111, that is a big cost - and a big dent in their reserves.

This week, the Government Actuary estimated the cost of the guarantees to the insurance industry at between pounds 6bn and pounds 7bn - more than it is costing to compensate the urgent cases in the giant pension mis-selling scandal.

Sun Life of Canada, a financially strong company, has been one insurer that has admitted the full cost of the guarantees - pounds 114m in extra reserves. The figure, with other factors, contributed to a difficult year for SLOC, which pushed the insurer into its first worldwide loss for more than a century.

For Equitable Life, however, annuity guarantees seem to cost very little. Dr Abrams thought his policy guaranteed him an annual income of at least 10 per cent of his total pension fund. Thinking he was safe from market fluctuations, he even thought of transferring some money from another pension into his Equitable Life policy.

Alas, no. Equitable has told him its guarantee only applies to part of his fund. If he wants the guarantee, he must sacrifice part of his terminal bonus - a sizeable chunk of the pension fund. If he wants the full terminal bonus, he must put up with a much smaller annuity rate. If he does not, his fund is reduced by 20 per cent, giving him thousands of pounds less in income.

Equitable partly defends this on the basis of being "fair" to customers who were never offered guarantees. But Dr Abrams is puzzled and angry: he believes his annual statements have always led him to expect a full fund, including the terminal bonus.

"At the end of the day, this guarantee was worth nothing to me. There is no reason for reducing the final bonus. I think it is moving the goal- posts. It is inequitable as far as I'm concerned: a right mess."

Tony Hogbin, a manager at Equitable's client-servicing centre, tried to explain in a letter to another angry policyholder: "To date, we have quoted the full fund value on the assumption that current pension annuity rates are used. This, in fact, is generous for many of the older forms of contracts. If those guaranteed annuity rates are to be used, then a different, lower final bonus amount is used. To date it has not been necessary to spell that out."

An Equitable policyholder may feel perhaps it should have been. With a total fund of pounds 160,080, one policyholder could expect an income of pounds 16,248 if the terminal bonus were paid in full. As it is, the policyholder will get pounds 15,209 - exactly the same as if there were no guarantee at all.

Nigel Webb, Equitable's spokesman, says the insurer has made this policy clear from the start in its contracts, and has always tried to be fair to policyholders, adding that he was not aware of any complaints. Some have benefited from the guarantee in other market conditions, he added.

However, a number of policyholders who are not satisfied with Equitable's answers are now going to the ombudsman at the Personal Investment Authority.

Given the potential pounds 7bn cost of paying the annuity guarantees, insurance companies are looking at a significant dent in their reserves - an important point for the financially weaker ones.

Stuart Bayliss, managing director of the specialist adviser Annuity Direct, says many companies are failing to let customers know if they have the guarantees - a feature which could boost their retirement incomes substantially. Customers who do not know they have them could plump for an ordinary annuity, giving them a retirement income hundreds if not thousands of pounds short of what they could get.

Terence Curzon, a 65-year-old former maintenance engineer from Northampton, only discovered he had a guarantee - and a better rate - after he asked Annuity Direct to convert one of his pension arrangements, a Scottish Widows personal pension taken out in 1993, into an annuity. If he had gone to Legal & General, his pounds 11,529 fund would have paid an income of pounds 1,072.20. With Scottish Widows, it would have paid pounds 999.56. Then Annuity Direct found the guarantee. Under the guarantee, Scottish Widows would have to pay him pounds 1,280.87 - a 20 per cent rise in income.

"It was rather a surprise that they hadn't told me, though I had had very little contact with them because I set it up through a financial adviser. I'm not financially minded and didn't know it was in the small print," Mr Curzon said.

Scottish Widows does warn people automatically they may have a guaranteed annuity, but only four weeks before the retirement date. Customers who want to get things organised before then may miss the fact they have a guarantee at all.

Customer service staff have failed to tell customers phoning in that they have a guarantee. In some cases, staff have not even had a clue what the guarantees were - so why should the customers?

With annuity rates at an all-time low, few experts expect them to pick up. In those circumstances, everyone about to buy an annuity should check for a guarantee.