4 September 2012 last updated

UK annuities would lower if Eurozone AAA rating was downgraded

UK annuities under threat if the credit rating downgrade for the European Union is give by credit agency Moody's. The credit agency Moody's has warned it may downgrade the European Union from the current AAA rating and has placed the outlook to negative from stable. This means if the European Union continues on the current course it may face the prospect of a lower rating. The implications would be significant for UK annuities as many institutional investors must hold a certain percentage in AAA rated bonds and gilts. If the UK retains this rating and the EU does not more funds purchasing UK government bonds and gilts would increase the price and reduce the yield with the effect of reducing annuity rates further. The statement from Moody's is ahead of the European Central Bank (ECB) meeting to explain how they will support the euro and member states that require a bailout.

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The risk to EU and UK annuities

The risk to UK annuities would be for the UK to retain the AAA rating while the European Union is downgraded as this would represent an imbalance of the current position resulting in a flow of investor funds to UK government bonds and gilts. It is more likely that the UK would also be downgraded if the EU is downgraded as Moody's have indicated the AAA rating depends on the strength of the main contributors to the EU budget accounting for 45% of revenue, Germany, France, UK and Netherlands.

Another risk is if the rating of the four main contributors were downgraded this would trigger the downgrade of the EU rating. The other trigger is that the members do not prioritise their commitment to the debts of the EU and this brings in to play the ECB and their plan to support the debts of sovereign members by using the European Stability Mechanism (ESM). The ECB will hold their meeting on the 6 September to provide more details of how this will work and will form part of the medium term review for the EU rating.

Risks that affect the creditworthiness of the EU are therefore the rating position of Germany, France, UK and Netherlands, the creditworthiness of other member states and the commitment of member states to maintain a fiscal framework to reduce the risk of future bailouts. If the UK credit rating could remain at AAA while the EU is downgraded UK pension annuities would be significantly lower although it is more likely that all the main contributors would be downgraded at the same time.