Re assurance – What does the Budget announcement on pensions mean for UK life assurers?


Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

One of the standout aspects of the 2014 budget was Chancellor George Osborne’s announcement that British retirees will no longer have to use their pension pot to buy an annuity. Whatever this may mean for the personal finances of the UK's population, the news set the cat among the pigeons in the diversified life assurance sector, for which annuities have been a good line of business.

Looking through some gloomy headlines, however, what does this really mean for the sector? Here on The Value Perspective, we would argue the long-term trend for retirement savings remains intact – in short, more people are living longer and need to save more – and, as such, the amount cumulatively invested in pensions should increase naturally. That is a significant growth driver for life assurers.

The short-term picture may be more uncertain – clearly the industry is heading into a difficult period for sales – but, ultimately, the cash generation of life assurance businesses and thus their dividends will remain unaffected. That is because that cash generation is driven by the companies’ ‘back books’ – in other words, the policies that are already in place.

There will be some implications for the accounts of life assurance companies, which is a complicated area at the best of times. to offer one example, while the ‘embedded value’ from existing annuity policies will not be affected by the changes, all new policies on a company’s books will be difficult to value with any level of accuracy.

Embedded value is effectively the ‘discounted’ cash flow – that is, set out in today’s money terms – of all the policies a life assurance company currently has in place. As things stand, discounting annuities is relatively straightforward because the company knows precisely what it has to pay and, with decades of experience, statistics and actuaries can offer a reasonable idea of how long it will have to pay it for. The company also knows the assets backing the annuity – in other words, what it has invested in on the other side to generate the funds to pay annuity holders.

Once people are allowed to draw down the cash flow of their pension at wills, however, discounting that becomes an impossible task. If a company does not know when people will access their pension savings, nobody can know what the embedded value will be. Still, while, it could potentially mean lower growth in embedded value, it will not reduce the embedded value companies already have.

Ultimately, when anyone is retiring – or indeed saving – in the UK, it is difficult for them to avoid touching a life assurance business in some way. To pick a few examples at random, you might buy an index-tracking fund from the investment arm of legal & general or invest through a standard life wrapper or run a portfolio via a Skandia platform, which is owned by old mutual.

Yes, investment specialists such as Hargreaves Lansdowne are likely to see some extra business as a result of the budget yet, offsetting that, the life assurers should benefit from the UK’s evolving demographic profile mentioned earlier. Irrespective of any change, one thing remains constant – annuities are the most tax-effective way of utilising your savings pot.

Although the changes are likely to unleash a wave of product innovation, the net effect should be minimal. Given the unchanged cash generation, dividends should be secure so, in our view, the ultimate value of the sector appears reasonable. Whether you liked or disliked the sector before then – other than slightly lower valuations – there is little reason to change your mind.

As a postscript, arguably greater impact on that value has resulted from a Daily Telegraph article that followed a ‘pre-briefing’ by the financial conduct authority (FCA) about the results of a probe into the insurance industry. Headlined savers locked into 'rip-off' pensions and investments may be free to exit, regulators will say, the piece led to billions being wiped off the sector in a single day.

When the FCA's report was published, however, it turned out it contained precisely the sort of things you would expect a regulator to do – an examination of due-diligence procedures, conflict-of-interest controls, sales practices and so forth. What it did not contain, however, was any suggestion of scandal or that the FCA was gearing up for an all-out attack on life assurance businesses.

Regardless of what The Value Perspective may think of the whole episode, Andrew Tyre, the MP who chairs the treasury select committee in the House of Commons, has called it an “extraordinary blunder” while, in an open letter to the FCA, George Osborne has professed himself “profoundly concerned”. Reading between the lines of that letter, it is possible some longer-term effects of recent news flow are felt outside of the life assurance industry.


Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

I joined Schroders in 2000 as an equity analyst with a focus on construction and building materials.  In 2006, Nick Kirrage and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Nick and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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