UK Pensions Annuities and Gilt Yields enter an Alice In Wonderland universe

Yesterday there were three pieces of news which in fact were interrelated even though they came from opposing sides of the Atlantic Ocean. Let me present them in chronological order.

The Executive Board of the Riksbank has decided to make monetary policy even more expansionary by cutting the repo rate by 0.15 percentage points to −0.25 per cent and buying government bonds for SEK 30 billion.

 

The (UK) Chancellor has announced that the government will extend its pension freedoms to around 5 million people who have already bought an annuity.

 

(Bloomberg) — Money-market futures traders cut the odds of a Federal Reserve interest-rate increase below 50 percent until December after Chair Janet Yellen lowered her outlook for growth and the pace of policy tightening.

 

These three apparently unrelated moves are in fact part of the trend to lower interest-rates and indeed bond yields that has been evident throughout my career. There have been ebbs and flows but the Status Quo has been this.

Get down deeper and down
Down down deeper and down
Down down deeper and down
Get down deeper and down

 

The Swedish Riksbank seems to have lost what little part of the plot it had retained and cut again against the bankground (background if you prefer) of a strong economy. Then if we move to the US Federal Reserve came a move which regular readers will know I was expecting. It removed the word “patience” from its report but then stepped backwards rather than forwards on the subject of a future interest-rate increase in the United States. One is coming soon or maybe later or maybe not at all as it desperately tries to mimic the boy or rather girl in this instance who cried wolf. Or in terms of Guns and Roses a bit more than a little patience will be required.

Said, woman, take it slow
It’ll work itself out fine
All we need is just a little patience

 

Government Bonds

This is where the link between the UK and US news comes in. As well as the extraordinary drop in the US Dollar ( The UK Pound nearly made US $1.50 as traders were stopped out) there was a surge in US Treasury Bonds. The ten-year Treasury Note shot higher and the yield dropped through 2% to 1.92%. But it a way more important for this discussion we saw the long bond or thirty year rally two whole points as the yield dropped to 2.52%. The yield had been falling anyway as poor economic data continued to appear. Yes this weaker data was continually described as a “surprise” which those of you who have seen my exchanges on twitter with Newsnight economics editor Duncan Weldon may already have noted.

Those who listened to the Budget analysis on Share Radio would have heard me point out that Germany was at an all time high for bond prices and consequently low for yields. As I type this the ten-year yield has fallen to 0.19% according to MTS which is yet another high. Now if we move to the UK we are seeing the pressure build too especially now that the US is moving. Accordingly the UK Gilt market has rallied today and our ten-year yield is 1.55% and more to the point of today’s discussion the 30 year Gilt yields 2.36%. Both are hard to type for someone like me who has so much experience of much higher numbers.

Long-Term Contracts

These have a problem with such low interest-rates. Imagine for a moment an annuity provider in Germany for example looking to offering deals to people 2,5,10 and 30 years into the future. In the first two instances it faces negative bond yields so it would have to offer less than paid in. What a great deal! Moving forwards a 30 year yield on 0.65% offers very little return as the concept begins to implode.

The UK annuity market is not yet at that extreme but with a 30 year yield of 2.36% yields are really rather poor. Or to link matters virtually anyone who has taken out an annuity in the past will have got better terms than they can now. Of course many of them thought that they were getting poor terms! In essence annuity rates are the flip side of falling bond yields.

As an aside final salary pensions just got a little more attractive again or putting it another way we will see less and less of them in future.

Annuity Rates

Many with a pension scheme have found themselves facing this conundrum. From the Pensions Advisory Service.

Over recent years, annuity rates have fallen as we have moved into a low-interest rate environment and annuities have, consequently, become less popular.

 

Add that to an illustration showing you losing 3% per annum as discussed in the comments on here and no wonder pensions sometimes get a bad press!

If you crunch the numbers for a basic (single life no add-ons) annuity at age 65 then it takes around 17 years to get your money back. This is awkward and leads to the view that an annuity is bad value. The government heard the cries of “we would rather keep the money and spend it” and as it mulled the issue no doubt the thought that older people are more likely to vote saw it saw well why not let them?

There are two contrasting views on this. Firstly it frees people up to do what they want with fewer restrictions which is a good thing. However on the same road we see that there is the danger we are borrowing from the future one more time. We are doing that rather a lot these days and for the moment let us ignore the nightmare scenario that the money goes into buy to let investment in the UK property market.

What about existing annuities?

To a government the fact that there are around 5 million annuities must be tempting as of course they are in a population demographic which is likely to vote. They currently are as a group in “profit” as some will have terms vastly better than available now some a lot better and other simply better. No doubt someone somewhere has a loss but this will very much be the minority. Easy money?! Not quite as of course there is another side to the arrangement which is the pension or insurance company which will in generic terms have hedged its position in UK Gilts which will have bought corresponding gains. Oh hang on everybody cannot win! The circle is squared so to speak by the fact that the insurance company is losing on its annuity book compared to current values and prices. It is not even a zero sun game as the pension company will have set out to make a profit so it is in fact a negative sum game.

But our brave establishment knows no bounds in its efforts to borrow from the future or as it puts it give more freedoms! Accordingly we will in 2016 get this.

From April 2016, the government will remove the restrictions on buying and selling existing annuities to allow pensioners to sell the income they receive from their annuity without unwinding the original annuity contract.

 

Hooray so they can take their profit? If you think that please hold your horses and read my explanatory paragraph again. Here is the official version.

it allows the annuity holder to access the value of their property rights where they can find a willing buyer. The annuity provider would continue to pay the annuity payments for the lifetime of the annuity holder, but would reassign those payments to the purchaser.

 

So we are reminded that this is a personal contract dependent on an individual’s life. Time I think for Alice In Wonderland to help us out.

I can’t go back to yesterday because I was a different person then.

 

Why, sometimes I’ve believed as many as six impossible things before breakfast.

 

Putting it in more sophisticated terms perhaps then this reply to making my views known on twitter sums it up. From @NotGiacomo

you don’t think we should trust consumers to correctly price their own derivatives contracts?

 

Comment

Somewhere in this UK establishment version of Alice’s Wonderland the following scenario will play out. Grandad or Grandmother will sell their annuity and take the cash. Then they gift some money to their granddaughter Alice who needs some help to buy a house as she is struggling with her student debt burden. Alice will use the benefit of her university education to figure out that for every £100 she gets from the bank of Grandad/mother she will get another £25 from the UK Taxpayer.

have i gone mad?
im afraid so, but let me tell you something, the best people usually are.

 

If we move back to the pension changes and overlook the dangers of yet another misselling scandal, how many more times are they going to change the rules? I have the formal qualification from the Chartered Insurance Institute but threw away my textbooks the other day. In spite of being recently purchased they are relics of another era.

I wonder if I’ve been changed in the night. Let me think. Was I the same when I got up this morning? I almost think I can remember feeling a little different. But if I’m not the same, the next question is ‘Who in the world am I?’ Ah, that’s the great puzzle!

 

 

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22 thoughts on “UK Pensions Annuities and Gilt Yields enter an Alice In Wonderland universe

  1. Hi Shaun

    I’m afraid you have missed out the most important issue of all in your write up.

    The financial services industry needs a constant supply of “rip off ” targets to survive and prosper. These changes to the pension regime will guarantee one thing to pensioners: they will be very poor value, complicated and designed to confuse and bamboozle.

    Also with the median annuity pot being around £35K I’can’t see any rush into BTL with those sorts of funds (although those with DB pots will have more) unless of course there is a surreptitious relaxation of lending standards, which of course is completely out of the question isn’t it……..or maybe not!

    The gyrations to square the circle without addressing the fundamental issues are picking up speed!

    • Hi Bob J

      I take your point about there being many annuity pots too small for BTL purchases. However there will be a fair number with more…

      As to the “rip off” targets in a way this starts with the UK establishment who keep changing the pension rules. I did the AF3 CII qualification about 7/8 years ago and that knowledge has been completely replaced. How does that work in an industry which requires long-term planning?! The LifeTime Allowance or LTA was supposed to be of the order of £2 million now and instead is £1 million. Now maybe many are not bothered by pension pots that size and to some extent I sympathise but the principle established is dreadful

  2. The purpose of the -3% model is anti-annuity propaganda.
    The govt. wants your pension fund in the economy NOW!

    More Status Quo:

    “Guess I didn’t make it in the city, but that’s just the way that it goes
    Cause there’s a lotta lunatics, crazy ghostmen, baby, don’t like the shape of my nose…”

  3. Thank you very much for the updates on so many economies, Shaun.
    With regard to Sweden, have you read this slightly dated Economist article that describes the developing Swedish housing bubble:
    http://www.economist.com/news/finance-and-economics/21614165-house-prices-europe-are-losing-touch-reality-again-deflating-bubbles
    The article argues that “[c]entral bankers cannot use interest rates to deflate the housing bubbles since, asset values aside, the economies of the countries concerned remain so sickly”. This may be the situation for some central banks, but as you note, it certainly doesn’t describe the current situation of the Riksbank.
    The Economist seems to put an uncritical faith in macroprudential tools to fight housing booms. However, the recent report by Sweden’s SEB indicates this faith may be misplaced:
    http://sebgroup.com/press/news/record-high-optimism-on-swedish-home-prices
    It notes that the SEB’s housing price indicator (HPI) is at an all-time high, with a record 74% of Swedes expecting prices to be higher 12 months ahead. It also notes: “While the Riksbank during the past 1.5 years has focused on inflation, cutting rates to a record low zero per cent in October, MACRO PRUDENTIAL POLICY HAS OBVIOUSLY NOT SUCCEEDED IN DAMPENING THE HOUSING MARKET. Home price increases have picked up and Swedish households are accumulating debt at an accelerating pace.” (Emphasis added.)
    Of course the inflation rate is only so low because of the dysfunctional manner In which the Swedish CPI measures owner-occupied housing costs, at least for the purposes of the Riksbank, and would be considerably higher if a net acquisitions approach were used instead.

    • Hi Andrew

      Thanks for the links. As to the first one I am not sure exactly when The Economist magazine became a part of the world establishment but I am sure that it has been so for a while! Accordingly one of the few cures for a house price bubble (higher interest-rates) is rejected and macroprudential policies which have a long track record of failure are not only accepted but proposed. It is sad especially for readers who are hoping for some insight.

      The Nordic nations in general have an issue here as lightheartedly I suggested to a Norwegian last night that they should all rejoin a Sterling Bloc! However of course we have our own troubles in this regard…

  4. I wonder if anyone recognizes how dangerous this debt slavery is?

    If I recall rightly if I was a Roman legionaries I would ( if I survived) at the end of 25 years be pensioned off with enough money for a small farm

    these days even a 25 year mortgage is going to last 35 years or more

    I suspect this will lead to pensioners with large mortgage debt , something seen already and will increase . This inevitably leads to the conclusion all you are doing is renting you house at extortionate rates from the Bank

    No matter how hard you work, no matter how much you sacrifice, the debt can never be paid off = debt-slavery

    Read more: HOW YOU BECAME A SLAVE TO THE BANKERS! | WHAT REALLY HAPPENED http://whatreallyhappened.com/WRHARTICLES/slavetobanks.php#ixzz3UqDvLEG4

    Haven’t you noticed we’ve all been blagged into having pension schemes just at the point that they become worthless to hold? or in fact cost you more to hold ? Who does that benefit ?

    Even if the returns are positive how much to you need save to keep your life style in old age, one figure I saw was as much as you put into your mortgage , ie pat 2 mortgages !!

    This is why I think we are circling the drain (CTD) ……..

    Forbin

    coming to you soon Dune: The Bankers Edition , set in the near future amidst a feudal inter continental society ……..

      • Shaun , can they print more QE to fill the pensions hole ?

        status quo – again and again

        why not I guess , hehe !

        Forbin

        • Hi Forbin

          You raise a few issues. Let me start with QE, as it has been the cause of quite a few issues with final salary pensions in the UK there would be not a little irony in QE for pensions! The debt issue seems all very Harkkonen to me.

          I like the idea of a 25 year mortgage lasting 35 years, how very credit crunch era….

  5. Hi Shaun,

    While thinking about all time low yields, I remembered a day in the city. Small bond yield changes get multiplied by the term in years, so that a 1% increase in yield on a 30 year bond might cause a 25% or 30% drop in price.

    So even a small interest rate rise may cause a financial tsunami …..

    • Hi ExpatInBG

      You are right to point this out. As the Heta Bank scandal continues to erupt and pose questions for Austria is it a rude time to point out that a bond with a par of 100 has traded at 200? What could go wrong….?

  6. Hi Shaun
    Time was that mankind was held in sway by the high priests of mythical gods and the slaves proved their worth by building pyramids or such like with the occasional sacrifice thrown in to keep everyone under control.
    Now we have become really sophisticated and the new ‘banker priests’ have us worshipping the mythical god of ‘GDP’ with the bonds of slavery being our lifetime debt. I think we all know instances of ‘sacrifice’ to keep those bonds tight.
    I am reminded of those original Star Trek episodes when Kirk and the dear departed Spock used to land on a planet and tried to rescue the population from some entrapment by ‘snake salesmen’ ( this was before the time of the ‘prime directive’). Perhaps we need a visit from ET!

  7. Hi Shaun,
    We have been heading for a massive crisis since the 1980s when I was working in the pensions industry. We’ve finally given up haven’t we? HEY! I know…..Let’s just call time on annuities and invent some new ‘investment’ fit for the 21st century. Maybe link it to the stockmarket or property-they’ve always done well historically. What could go possibly wrong?

  8. “But I don’t want to go among mad people,” Alice remarked.
    “Oh, you can’t help that,” said the Cat: “we’re all mad here. I’m mad. You’re mad.”
    “How do you know I’m mad?” said Alice.
    “You must be,” said the Cat, “or you wouldn’t have come here.”

    It’s incredible Shaun. Ever more inventive ways….

    “How puzzling all these changes are! I’m never sure what I’m going to be, from one minute to another.”

    “Curiouser and curiouser!”, said Alice.

  9. Hi Shaun,
    I’ve been too busy to look at anything the last couple of days but this post compels me to comment as you raise so many issues so here goes although I know you won’t respond to comments on old posts this is to get things off my chest and for other readers to consider:

    Re annuities being sold – There is nothing new here, this was happening in a way many many years ago with now largely defunct endowment policies (whose final payment depended upon premiums being maintained to a future date or the death of the original policy holder whichever came first i.e. “a personal contract dependent on an individual’s life”) being sold off sometimes at a 30% profit on the surrender valuation provided by the Assurance company which in itself expressed a profit over the premiums paid. So, if you’re smart and know where to invest the proceeds of your annuity sale (and no I’m not thinking btl) then it is indeed a good thing because it’s not about “taking their profits” but putting the money to better use than the useless pension fund managers have done thereby stopping ongoing losses (remember pension fund managers keep receiving their fat pay checks no matter how abysmally they perform as it’s these same managers who “invested” Endowment contract premiums and we saw how that ended). This is probably not for the vast majority of the population, but then as Clint Eastwood says ” a man’s gotta know his limitations”.

    In terms of “borrowing from the future” well, ever twas thus. Remember the massive privatisations of the 80’s of the utilities and British Steel etc for a one off junkie injection of money into the system? Think “back door QE”. Once the privatisations were complete that was it – no entitlement to ongoing profits, just a small tax share. The unlocked annuities are simply a new source of money for the financial system and an admission by the Government that, just as it rolls out compulsory auto enrolment, the dinosaur that is the contributory private/occupational pension has no more relevance to modern day finance than the …er,,. dinosaur! This as a result of the artificial compression of yields by CB’s globally..

    Regards pension changes did you know there have been 20+ changes to State Pension since 1979? It was clear to me back in 2000 when a pension salesman was trying to get me to either convert my final salary pension into a contributory money purchase scheme and pay more premiums into it on top, or simply start a new contributory pension scheme (additional voluntary contributions) to sit alongside my final salary scheme, that, given the opaqueness of underlying investments, the fact I couldn’t direct which Fund managers the investments were to be placed with (although this changed on 2006 with the implementation of administratively expensive Self Invested personal Pensions) and teh numerous changes which had been made to personal pensions regulations even then in the context of a long term 20+ year contract that it was a complete total and utter non starter as a long term contract requires stability of terms and conditions i.e. regulatory stability.

    So I chose ISA’s instead which had been steadily improved upon since their first incarnation as PEP’s with the lack of tax breaks on contributions compared to pension contributions being a tiny price to pay over controlling your money and my how well I have done compared to the average contributory pension scheme. in fact, in many cases you would have outperformed the average pension fund manager just by investing in a selection of index trackers!!##**&””+

    Two final things:

    1. Am I the only guy on this forum who has no debts? With the exception of my Credit Card which is paid off every month affording me interest free credit I have no debt – no mortgage or personal loan or HP etc. The impression I get from the comments section is that every one else is indebted. My point is with the exception of your mortgage unless you are on low pay, debt is a choice – NOT COMPULSORY.

    2. “but then stepped backwards rather than forwards on the subject of a future interest-rate increase in the United States”

    If this is what you believe then I think you’re in for a “surprise” Shaun – see what the US economic data looks like this May/June and then see what the Fed does this September/October…

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