18 July 2012 last updated

Annuities pressured as 15-year gilt yields at all time low

Gilt yields fall to 2.03% reaching an all time low due to effects of QE from the Bank of England and Spanish debt crisis will pressure annuities. Since reaching a high on 3 July this month of 2.31% gilt yields have been falling for the last two weeks to end at an all time low for the 15-year gilt yields of 2.03% after reducing by 3 basis points today. This fall represents 28 basis points so far this month and as a general rule this would translate to a fall in annuity rates of 2.8% at some time if gilt yields remained at this level. As an example if this decrease was reflected in rates for a 65 year old male with £100,000 and an annuity on a single life, level basis the current income of £5,962 pa would reduce by £166 pa to £5,796 pa. For a 100% joint life both aged 60 and on a level basis this would mean the current income reducing by £90 pa from £3,228 pa to £3,138 pa.

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Providers reducing annuity rates

Gilt yields started the month by increasing on the back of the Eurozone bank debt deal that resulted in yields increasing by 11 basis points to 2.31%. Within a few days investors turned their focus on Spain's debt crisis with fears that the cost of borrowing was returning to the unsustainable 7% which would trigger a bailout. Coupled with this the Bank of England announced £50 billion of Quantitative Easing (QE) on the 5 July and yields have since plummeted to their current low levels.

Only smoker and impaired annuity rates have reduced during this time by about 1.0% so providers have not fully reflected the decrease in gilt yields in the short term and are waiting to see how the market develops. QE has the tendency to impact gilt yields quickly which then rebound over the following week.

It is likely that standard annuities will remain level as the current leading providers Legal & General and Canada Life have already reduced rates significantly in June when yields reduced by a significant 55 basis points. They have exhibited the tendency to resist changing their rates while others providers have made reductions.

More QE later this year

The minutes from the Monetary policy committee (MPC) show that the Bank of England were planning to inject up to £75 billion using QE and this technique of electronic money to purchase UK government bonds and gilts has the effect of increasing the price and reducing the yields of gilts including the 15-year gilts used by annuities.

Quantitative Easing has now increased to £375 billion and there is a risk to pensioners that annuity rates will continue to fall if the BoE considers QE later this year. This would happen if the euro comes under greater pressure of a break-up, inflation continues to fall below the 2% level target set by the BoE and/or the economy fails to improve.

Risks in the Eurozone are high with the International Monetary Fund (IMF) warning EU leaders that decisive action is required as Spanish 10-year bond yields reach 6.94%, very close to the unsustainable level of 7%. Spain has received 100 billion in bailout funds for it's banks and announced spending cuts of 65 billion and it is likely that this particular debt crisis will continue this year and reduce the annuity income for UK pensioners.