A new report from rating agency Standard & Poor’s concludes that UK insurance companies will continue to be attracted to infrastructure investments in spite of a measure introduced in last week’s Budget that is expected to slash the volume of annuity products sold.
In the low interest rate environment of recent years, insurers have increasingly switched away from government bonds towards illiquid securities such as infrastructure projects as a way of achieving higher returns while matching their annuity liabilities. This trend was typified in December last year when a group of insurance companies pledged to invest £25 billion (€30 billion; $40 billion) in UK infrastructure over the next five years.
However, last week’s Budget from Chancellor George Osborne attempted to liberalise the market by removing the requirement for retirees to use their pension pots to purchase an annuity (an investment product that pays out a fixed annual amount over a specified period). As well as having the option to buy an annuity, pension policy holders may now withdraw all or some of their pension pot to spend or invest in any way they choose.
In Australia, where such a measure has already been introduced, only one in 25 retirees now choose to buy an annuity, according to research from investment firm Challenger. If the UK experience were similar, it would deliver a huge blow to the £14 billion annuity market.
The S&P report acknowledges that “a fall in the volume of new annuities being purchased will likely curtail insurers’ long-term capacity for investing in illiquid assets”. However, it added that “if the total size of the annuity market shrinks, it will increase the need to be competitive and the need for yield”.
The report (titled “UK annuity volumes will suffer until greater clarity emerges on policyholder response to Budget”) adds: “Where insurers can benefit from higher returns by investing in illiquid assets, with limited extra credit risk, we believe they will continue to do so.”