So what now for annuity rates?

The recent reductions in the Bank of England Base rate have been welcomed by many although the size of the reductions implemented have been higher than many had expected. 

So what impact will this have on annuity rates?

There is no direct correlation between the Bank of England Base Rate and annuity rates.  Annuity rates are determined by long-term Gilt and Corporate Bond Yields together with estimates on life expectancy and competition between product providers.

Does this mean that annuity rates will be unaffected? I don’t think so.

Even though there is no direct link, in the past we have seen annuity rates fall following a reduction in the Bank of England Base Rate.  On this occasion, however, I do believe that there are additional factors that would result in a reduction in annuity rates.

In general, when interest rates rise, the price of fixed interest securities such as Gilts and Corporate Bonds usually falls resulting in an increase in the yield.  Conversely if interest rates fall then the price of fixed interest securities rises resulting in a reduction in the overall yield, which could have a negative impact on annuity rates.

Over and above this I do believe that there could be some concerns regarding potential defaults on Corporate Bonds held by annuity providers.  The reduction in interest rates has been far greater than everyone had initially expected and as such many are concerned about the potential outlook of the economic climate over the medium term. 

Are things worse than we believe? Who knows?

Interest rate cuts of this magnitude can not be ignored and I estimate that annuity providers will err on the side of caution and look to reduce annuity rates, at least in the short-term, until further information can be obtained with regards the future economic outlook.  If matters are worse than expected and defaults on Corporate Bonds occur then this could have a detrimental impact on annuity rates.

In addition annuity rates earlier this year were the highest they have been for almost 6 years.  This, together with the recent fall in interest rates, the possible increase in potential defaults on corporate bonds, the increase in life expectancy and companies wanting to err on the side of caution in difficult market conditions, could result in annuity rates falling over the coming months.

Will the potential fall in annuity rates be offset by any potential gain in fund values? Only time will tell.

To discuss this or any other annuity issues please contact Sean McCabe on 01225 823555 or email sean.mccabe@chartwell.co.uk