The recession and financial market turmoil is having unforeseen effects that providers and advisers need to consider when communicating with and advising customers.
Take annuities as an example. Insurers normally hold at least a proportion of assets backing their annuity books in the form of corporate bonds. Yet despite a sharp rise in AA corporate bond yields since 20071, annuity rates have failed to follow these yields north. There are two reasons for this. Insurers might have increased the proportion of long-dated gilts they hold. Unlike corporate bonds, the yield on these has fallen2. Or they might have increased the assumed rate of corporate bond defaults, which has the effect of bringing down the nominal yield.
Some commentators are now urging people to lock into annuity rates today (despite fallen fund values) as they expect that corporate bond yields, and thus annuity rates, will fall. That may indeed happen, but if corporate bond yields do drop, then one reason why might be that the risk of default has receded. In that case, insurers might therefore reduce their assumed rate of default with the result that the post default yield could be the same or perhaps even higher than before.
We also know that the government plans a massive gilt issuance of £146 billion this year3. Economic theory tells us that when the supply of anything goes up, then the price will fall unless demand also rises by a similar amount. If demand for gilts doesn't rise in line with supply then prices will fall and yields will rise.
These arguments about the potential direction of corporate and government bond yields put the counter view to those already publicly espoused - hold off buying an annuity until tomorrow because the rate will go up.
Personally, I have no inkling of how bond markets might pan out this year, or next for that matter. Nor whether yields will rise or fall and whether annuity rates will follow. Therefore, in my view, recommending that customers time the market in the way that some are suggesting, is asking for trouble.
Why were these commentators not telling us to get out of equities and into cash last May? And, if they couldn't call the equity market then, what makes them think they can call the bond markets now?
In turbulent times, customers need to have their hands held. If possible and affordable, customers should delay taking big decisions until the future is more predictable. Why take bets on the way markets might move unless you can afford to lose? A plan that meets short-term needs, whilst keeping options open is preferable to painting oneself into a corner.
For those approaching retirement, there are a range of options available depending
upon how much savings they have within and outside pensions, and any other sources
of income. For example, from a defined benefit pension or from working. Before
we push customers down any track, today more so than at any time I can recall,
we should consider the full imaginable range of 'what-ifs?' first.
1. http://www.watsonwyatt.com/europe/pubs/statistics/render2.asp?ID=19
2. For example, FT Thursday 12th February, 20-year gilt yield on 11th February
2009 was 4.24%, 20-year gilt yield on 11th February 2008 was 4.52%
3. http://uk.reuters.com/article/breakingFundsNews/idUKLS70158420090128
Tax and legislation are liable to change. This information is based on Standard
Life's current understanding of law and HM Revenue & Customs practice.
Tax rates and reliefs may be altered. The value of tax reliefs to the investor
depends on their financial circumstances. No guarantees are given regarding
the effectiveness of any arrangements entered into on the basis of these comments.
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