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30 June 2013 last updated
Enhanced annuities up 7.8% and now at risk of falls in medium term

Gilt yields have soared to 3.08% with enhanced annuities rising to new levels this month to the benefit of people retiring but now look too high in the medium term and could mean a correction if yields fall.

Annuity rates closely follow the 15-year gilt yields and as a rough guide a 10 basis point rise in yields would result in a 1.0% rise in annuities.

In June yields are up 42 basis points following a 35 basis point rise last month and some enhanced annuities are higher by 7.8% this month. On average rates are higher by 5.11% exceeding the rise in yields which suggests enhanced and smoker annuities will reduce by 0.91% in the short term.

The reason for the rise in yields is due to the US Federal Reserve statement that they were going to reduce their $85 billion a month stimulus package and stop this completely by July 2014. This was driving the price of bonds and gilts higher and without the stimulus prices would fall and yields increase so investors have taken action now in anticipation of the future changes.

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Competition driving enhanced rates in short term

Providers of enhanced and smoker annuities are competing more aggressively than providers of standard rates with larger increases than we would expect when compared to gilt yields.

For people that suffer from a lifestyle medical condition such as high blood pressure, Cholesterol, are a smoker or are overweight increases in income of 18% can be offered from an enhanced annuity. For more serious medical conditions such as diabetes, heart conditions or cancer an impaired annuity could offer incomes increased by 40% over a standard annuity.

Providers such as Just Retirement are improving rates more as they have their year end approaching so need to meet certain volume targets. This is creating an artificial level for enhanced,smoker and impaired annuities in the short term but there are also stresses building in the medium term.

Over six months the 15-year gilt yields are 68 basis points higher with enhanced annuity rates higher by 8.51% for a single life basis and 12.90% for 50% joint life and 3% escalation. This suggests that in the medium term we can expect a correction with a decrease of up to 6.10% for annuities with certain features.

For people retiring now it means income from enhanced rates represents good value and could decrease in the future.

There are also differences for different ages. For example, single life enhanced rates over six months vary from age 55 to 75 as can be seen in the following chart.

Enhanced annuity increases
Fig 1: Change to enhanced annuities compared to gilt yields

In particular for ages 55, 60 and 65 annuity rates have increased well beyond the rise in yields. These age groups represents 95% of annuity purchases whereas very few people leave it until they are 70 or older to take their income. For those age 55 income levels have increased by 16.59% when we would expect a 6.8% increase so offers the greatest value of all the ages to take benefits.

Enhanced annuity changes expected
Fig 2: Changes expected to enhanced annuities in medium term

The above chart indicates the correction needed to bring enhanced annuity rates for a single life, level basis for those aged 55 back to levels we would expect, a decrease of 9.79%. In contrast for those aged 70 and over increases in rates can be expected of up to 2.67% in the medium term.

In the short term enhanced annuities are good value for money for people retiring now and if yields remain at 2.99% there would be a small downward correction of 0.91%. If yields fall further this correction would increase although any further improvement impaired annuity providers would be under less pressure to reduce rates in the medium term.

News related stories:
Best annuity rates could rise 8% as gilt yields soar 39 basis points
UK annuity income 7.7% lower as US Federal Reserve considers stimulus
UK annuity rates could rise 3% as gilt yields end on a high
Impaired annuity rates up to 4% higher as gilt yields rise
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  65 £5,098 £4,638  
  70 £6,055 £5,457  
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