The 2014 Budget was seen as a bomb planted in the lobby of the UK's leading annuity providers, triggered by radical policy makers determined to confront a market that had delivered poor value to savers for too long.
The initial blast hit specialist annuity providers hardest, after the removal of the imperative for many to purchase a guaranteed income at retirement led people to press pause on their retirement planning. Partnership Assurance (PA.) lost 60 per cent of its market value in the week following the announcement, while shares in Just Retirement dropped by a half in the same fraught period.
But the threat has fizzled out a little since the initial fireworks. Share prices across the 10 largest London-listed life assurers, having sharply dropped since the day before George Osborne took to the despatch box, and lagging the wider FTSE 100 for the year, have made up some of that lost ground in the first few months of this year (see graph below). This recovery was buoyed by a positive annual results season for many of the larger providers, as other parts of their businesses such as overseas and asset management operations grew healthily, along with corporate pensions.
There is also a growing recognition that 'pension freedom day' on April 6, when retirees will no longer be effectively compelled into buying an annuity, may not have the seismic effect initially feared by the market, with surveys demonstrating a popular desire for a secure retirement income.
But there is no escaping the fact that the contraction of the individual annuity market hurt these long-established businesses, with an average drop-off in sales of almost 40 per cent in the first nine months of 2014, according to industry data.
Mr Osborne could not leave the industry alone in this year's Budget either. But his proposal of a secondary market for 5m current annuitants has so far done much less damage. The government's consultation suggests annuity providers will have to sign off on any annuity being sold on a secondary market, with the original contract unbroken - that second point is crucial to the embedded value of these businesses, as profits are spread over the course of each contract.
Mark Wood, chief executive of broker JLT's employee benefits arm, and former head of Prudential, has said this arrangement should be "broadly neutral" for insurers, compared to a market where insurers were compelled to refund contracts. The value of 'in-force business', as the industry defines those older policies, seems intact. But some in the market will ride out the drop in new business better than others.
The prediction game
The nagging question ahead of April is how far people will turn their backs on annuities, and which alternative they will pursue. Providers are keen to predict this shift and design products to suit. "I think we will see a material change," says Steve Lowe, director at Just Retirement. "It will be people saying, 'I need to secure some income and I need to keep some flexibility'."
Insurance experts tend to segment the market. Eamonn Flanagan, insurance analyst at Shore Capital, cuts it three ways: above £500,000 in retirement savings, people are likely - as before - to draw down from their pension pot in flexible ways to suit their financial situation.
Below £50,000, people are likely now to take it as cash, while steering clear of tax pitfalls. "That impact has already been felt, because the annuity companies are not selling annuities to those people at the moment," says Flanagan.
There is more uncertainty in the world in-between. Savers at the larger end of the middle range may turn away from annuities to drawdown, depriving annuity providers of business they otherwise may have won. But again, Flanagan forecasts that uncertainty is "already in the share price" of the major life assurers.
The outcome for income
Longevity for these businesses is a function of their adaptability. Standard Life (SL.) has a blossoming asset management division, a strong offering in the 'anything but an annuity' market, and a growing corporate pensions business. The company seems well set up to traverse this year's hurdles. Its numbers are looking good. The company's fund manager Standard Life Investments boosted operating profits by 30 per cent in 2014, with assets under management up almost a half, and saw its workplace pension customers boosted by 340,000 to 1.6m.
Income drawdown is seen as a major beneficiary of last year's retirement reform as people decide to draw on their retirement pot in instalments, rather than hand over the whole sum to an annuity provider in return for a secure, but fixed, income. In this market, Standard Life led the sector last year on assets under management, according to a Money Management survey, and boasts a smaller exposure to individual annuities than some of its peers, who are now looking to join it in this sector.
Standard Life seems well set up to traverse this year's hurdles
Going bulk and beyond
Life assurers also redirected their sales efforts to bulk annuities, where a deal is made with company to insure a set of liabilities from its defined benefit pension scheme. This market will only grow as those scheme demographics mature, and employers want to get pension risk off their books, but at the same time it can be quite lumpy, dominated by big deals.
Last year, Legal & General (LGEN) was the dominant player in this market, with 45 per cent market share, according to figures from pensions consultancy LCP. Its largest deals were a £2.5bn partial buyout of US automotive company TRW's UK pension scheme, where it insured the future payments of more than 22,000 of the scheme's pensioners, and a similar £3bn deal with the ICI Pension Fund.
L&G's announcement in February that it would enter the equity release market by acquiring New Life Home Finance for £5m was seen by analysts as another example of how these companies are looking elsewhere for complementary business lines. Premiums from annuity business can be passed on to these new customers, giving the company a bond-like asset to back its pension payouts. The company has also benefited from its established asset management operations.
Refocusing overseas
Key areas of the UK life insurance sector are shrinking, so those companies that have strong overseas operations have been better protected from the government's intervention back at home. Here, Prudential (PRU) has demonstrated why it is our longstanding buy tip, with strong Asian and US growth making up for the hit on individual annuity sales in its UK life business. Its 'bancassurance' tie-up with Standard Chartered helped boost its sales in this region by a third over the year, and its asset management arm M&G delivered a fifth year of record profits.
But the company is not immune to the UK reforms, far from it. With its individual annuity sales cut by nearly half in 12 months, the company launched an income drawdown product to meet the flexibility demand of post-April retirees.
Aviva (AV.) also benefited last year from further expansion in its growth markets of Poland, Turkey and Asia. But regulatory shifts at home cast doubt over the logic of its Friends Life (FLG) takeover, which will see the companies seeking synergies and cost-savings in a crowded, and in some places shrinking, UK life market.
The risk is that these companies, flush with cash as they are, lose ground as their rivals expand their operations and their business lines. "The rest of the industry is moving forward," observes Shore Capital's Flanagan. Here the introduction of auto-enrolment, which kicked off in 2012 - requiring all employers to eligible workers into a pension scheme - has softened the blow. The combined group is expected to serve one in four of all the savers which enter this market, and as statutory minimum contributions from these savers begin to increase from 2017, those growing nest eggs could provide a rich source of future profits.
The most interesting remaining question for the market is how far the specialist retirement income providers can make up the ground they have lost. Partnership's bulk annuity business rose threefold last year to £247m, and we think there is scope for some recovery in the shares. Just Retirement (JRG) has benefited from its decision to start underwriting defined benefit schemes, and is designing products to meet the need it sees for both flexible investment products and guaranteed income.
But there is no guarantee that these lines of attack will create sufficient profits to regain past glories, leading observers to question: could these rivals ever join up? The prospect of one company, with a lower combined cost base, taking aim at this market is being openly discussed by market watchers. "There has to be a point at which Partnership and Just Retirement get together," says Flanagan.
The life assurers look to have steadied themselves ahead of April 6, but continued adaptation will be vital to stay ahead of the pack.
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