12 September 2012 last updated

Higher UK annuity rates expected as German court bailout approval

UK annuity rates were given a boost and could rise by 4% after the German courts ruling to reject an attempt to block the ECB bailout fund. The European Central Bank (ECB) had presented the plan to buy unlimited amount of bonds from struggling member states in addition to the European Stability Mechanism (ESM) which was challenge by opponents claiming that it was illegal. The ECB plan is good news for UK pensioners as it gives confidence to investors that their funds in European sovereign debt is safe from future bailouts as with Greece investors suffered significant losses. With the ECB plan in place it means more money will move from safe havens such as low yielding UK government bonds and gilts to Europe such as higher yielding Spanish and Italian bonds. This will reduce the price of UK gilts increasing the yield resulting in higher UK annuity rates.

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UK annuity rates could rise by 4% or more

Standard UK annuity rates could now increase by up to 4.3%, smoker annuities by 3.2% and impaired annuities by 4.4%. Pension annuities have been reduced by providers significantly over the past three months, further even than the fall in gilt yields and in particular the 15-year gilt yields for which rates are primarily based.

The 15-year gilt yields increased by 10 basis points to 2.28% and are up by 21 basis points for the month. As a rough guide this would translate to an increase for annuities of 2.1% and then you need to add the reduction in annuity rates last month of 1-2% when gilt yields actually increased by 0.3%.

As an example, a male aged 65 with a fund of £100,000 could purchase an annuity providing an income of £5,746 pa and a 4% improvement would increase this by £230 pa to £5,976 pa.

Eurozone bailout fund secured

The German court ruling means that the European Stability Mechanism (ESM) has been approved and can now be used to bailout struggling countries using a fund of 500 billion euros. This will be further enhanced with funds from it's predecessor of 200 billion euros making a total of 700 billion euros.

So the two plans of bond buying by the ECB for short term debt measures and and ESM for long term debt measures reduces the risk to investors buying the bonds struggling countries such as Spain and Italy. As a result the cost of the debt for Spain which was at one time at a yield of 7.6% for 10-year bonds has now reduced to about 5% and at manageable levels. This would allow investors to move funds away from UK gilts reducing the price and increasing the yields to the benefit of pensioners and higher UK annuity rates.