Annuity surrender or sale

[Logarithm n Blues]

Hi Forum,
I'm hoping someone can help me with this point of confusion:

Course notes and materials for SP2 comment that annuities 'Can be sold to secondary market in some jurisdictions'. I imagine that the factor here is regulation and the implication is that this is not usually allowed.

However couldn't this be done using a combination of fairly vanilla products?
eg. a company who wanted to offer this could offer:

-An interest only loan, that gives a lump sum on day one and charges regular interest payments (equal to the annuity payments) until repaid.
-A whole of life policy that can repay the loan on the death of the policyholder​

This would effectively swap the regular payments for the lump sum.

For an even more standard portfolio, it seems like we could use a very long term repayment loan packaged with a decreasing term policy. Maybe the companies involved could arrange to settle payments between themselves rather than paying the annuity and collecting the premiums from the policyholder?

I guess the main difference here is that the customer is involved in 3 contracts (instead of 0 contracts if surrender is allowed), but surely many customers would be happy with this?

 

[Lindsay Smitherman]

Hi - I'm not sure that I totally understand what you are suggesting here: is this intended to be a replacement opportunity for an existing annuitant to basically 'trade' their annuity benefit cashflows for a lump sum in a jurisdiction where surrenders and secondary market transfers are not available or permitted? (Yes, the availability of such a secondary market would be subject to legislation - but also would rely on market forces.)

The main issue here relates to anti-selective potential and value for money. A significant proportion of those wishing to cash in their annuities (that are already in payment) will be those who are in relatively poor health and who are thus not expecting to receive many further annuity payments. Consequently any value that would be offered on the secondary market would be pretty low (the market players would underwrite the individuals) - and may well not be deemed to be of sufficient value to the individual for them to take up the offer. Bear in mind also that the provider of the cash lump sum would need to take margins to cover their own expenses and also profit margin.

Similarly, annuities may be perceived to be poor value for money by the existing holders (who may thus wish to attempt to cash them in) at precisely the time when the amount that would be offered by the market would be relatively low (higher interest rates or bond yields than were used to price the annuities).

Indeed, the UK government's proposals to introduce a secondary annuity market a few years back was abandoned largely due to concerns relating to value for money (and the likely limited market size).

The same would seem to be the case for what you are proposing, if I have understood it correctly. The amount that an individual in relatively poor health would receive, after allowing for paying what would be a pretty expensive whole life assurance premium, would also be unlikely to be perceived to be good value for money by the individual. Also, as you say, the arrangement proposed involves more components and so there would be associated erosion of value from the costs involved - and of course the profit margins that would be taken by the provider(s).

Does that help to make some more sense?

 

[Logarithm n Blues]

Thanks Lindsay, that's really helpful.

I suppose my question is - what's the point in the legislature?
Suppose that:

• Mrs Smith is a UK annuitant who no longer wants to receive regular payments but wants to receive a lump sum instead.
  • She is in good health and willing to take full medical exams etc.
  • She is prepared to take a significantly lower lump sum than the primary annuity market prices due to her specific financial needs.
• WBAA ltd (we buy any annuity) are a UK financial services firm that would be happy to buy the annuity
  • They are very efficient at admin, contract design etc. and can do this at fairly low cost.
  • They can meet Mrs smiths low asking price while covering costs and making a profit.

In the UK, they would not be allowed to trade the annuity directly.
However they could legally do something equivalent if WBAA sells Mrs Smith the interest-only loan and Whole-of-life Assurance. It seems to me like all the legislature has achieved is to make the transaction a little bit more convoluted? What's the point? Is the goal just to make it more complicated and put people/firms off?

I accept that the market would be small - Mrs Smith and WBAA are rare special cases!

 

[Lindsay Smitherman]

I accept that the market would be small - Mrs Smith and WBAA are rare special cases!

I think that this final point hits the nail on the head!

In the UK, the main reason for the U-turn on the government's intention to permit a secondary annuity market was its concerns about consumer protection. In particular, given that it seemed that there would be relatively few companies interested in operating in that market, there would not be sufficient levels of competition to guarantee fair price transactions for individuals. So there were concerns about individuals being given poor value for money and also that it opened up greater potential for exploitation by scammers.

OK, so Mrs Smith might be happy with something that isn't particularly good value (don't forget that underwriting is pretty expensive so that is going to knock a fair chunk off her payment too, however efficient WBAA might otherwise be!) and maybe she is financially sophisticated enough to make that call - but consumer protection is there to protect everyone, particularly those who are less able to make such decisions.

I look forward to watching you set up your new 'loan+whole life' enterprise in due course & wish you all the best!

 

[Logarithm n Blues]

Thanks. That really helps to make it clear.

..maybe she is financially sophisticated enough to make that call - but consumer protection is there to protect everyone, particularly those who are less able to make such decisions.

In particular this is a really helpful insight that I think I was overlooking.

I look forward to watching you set up your new 'loan+whole life' enterprise in due course & wish you all the best!

Haha
Thank you. Of course your well wishes are not necessary since my business case is so good. I can however offer you an incredible opportunity to invest at the ground floor in WBAA (tm)