Pensioners hit by falling inflation

25 March 2009

Pensioners with certain annuity products could see their income frozen or even decrease as a result of falling inflation.

Earlier this week, government statistics revealed that one measure of inflation – known as the Retail Prices Index – hit zero in February for the first time in 49 years. Although the official rate of inflation – the Consumer Prices Index – rose slightly last month, economists expect it to also eventually hit zero and even potentially turn negative.

The falling cost of living should be welcome news for pensioners, especially as retirees tend to suffer from higher personal inflation than other members of society because their income is fixed and a large proportion is spent on food and utility bills. However, for those claiming an income through an annuity, the news could mean their incomes actually start to fall.

This is because many annuity products track inflation through the Retail Prices Index. When inflation was high last year, inflation-linked annuities grew in popularity, as people tried to beat the devastating impact rising prices can have on a retirement pot.

While the income from standard annuity products is static and can, over time, be eroded by rising prices, an inflation-linked product protects your retirement income as payments start off lower and increase over time.

However, with deflation now very much on the cards, people with inflation-linked annuities could see their income frozen or even fall, depending on their annuity provider.

According to the Association of British Insurers, around 27,000 people bought an inflation-linked annuity in 2007, but there are likely to be hundreds of thousands people with such annuities.

Laith Khalaf, pensions analyst at IFA Hargreaves Lansdown, says that annuity providers use the rate of inflation three months prior to you taking out the policy. Each anniversary, the provider again looks at the rate of inflation three months previously and amends your rate accordingly.

So, people who are approaching their anniversary at the moment should manage to escape deflation – but those whose anniversary falls in the summer months could be less lucky.

Research from Hargreaves Lansdown reveals that only four of the leading insurers offer inflation-linked annuities with rate guarantees, meaning the income a pensioner receives will not reduce even if inflation does.

This means many retirees are exposed to falling retirement incomes, at a time when they are least able to afford it. At best, insurers will freeze an investor’s income until inflation returns to positive territory.

As inflation-linked annuities are reviewed on an annual basis, pensioners will have to suffer the consequences of deflation for a full year - and they won't see their income rise again until inflation exceeds the previous positive pricing level.

Two of the biggest annuity providers, Prudential and Standard Life, do not offer rate guarantees (see table below).

Insurer Rate guarantee?
Legal & General Yes
LV= No
Norwich Union Yes
Partnership No
Prudential No
Reliance Mutual No
Standard Life No
Source: Hargreaves Lansdown

According to Hargreaves Lansdown, inflation needs to run at 5% a year for an RPI-linked annuity to be worthwhile.

Partnership, which provides annuities to people with ill-health, is another provider that does not offer customers a rate guarantee and, as such, will reduce customers' income in-line with any falls in inflation.

Ruth Clarke, marketing director at Partnership, says less than 1% of its customers have this type of annuity. She argues that the cost of offering customers a floor would significantly reduce the competitiveness of the annuity.
“In common with many others we expect inflation to take off again following the government move to adopt quantitative easing in which case income payments will increase accordingly,” Clarke adds.


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