The annuity apocalypse is overhyped – here’s a great way to profit

It looks like the annuity market isn’t going to collapse after all.

When George Osborne announced his pension reforms in March, many folk thought annuities would become a thing of the past.

But the latest update from Standard Life suggests that some new retirees do still want an annuity.

That means there are a couple of attractive opportunities out there for patient investors…

Annuity providers’ share prices have crashed

Osborne’s pension reforms have triggered some big share price movements since March.

The biggest faller has been the specialist annuity provider Partnership Assurance (LSE: PA), which is down 59% since the Budget. Partnership’s main rival, Just Retirement (LSE: JRG), is down 40% over the same period.

I can see why some investors have decided to sell out of both firms. But as I said in March, I think the prospects for Partnership and Just Retirement are rosier than many people realise.  And I believe that even more strongly now than I did back then.

That’s because more evidence has emerged to suggest that the annuity market won’t collapse completely.

Firstly, a recent survey by the accountancy giant, PwC, suggests that the market might shrink by 75%. That’s huge – but it’s not a total wipeout.

Secondly, I was cheered by yesterday’s corporate update from Standard Life (LSE: SL). The insurance giant said that annuity sales had only halved since Osborne’s announcement.

Granted, it’s very early days. As news about the pension reforms spreads, I suspect the annuity market will eventually shrink by more than 50%

But the PwC survey and the news from Standard Life strengthen my view that some folk will carry on buying. My hunch is that the market will shrink to around 30-35% of its pre-Budget size.

You shouldn’t write off these businesses yet

Also, you should remember that even if these companies never sold another annuity, they could both still make a profit. That’s because they can make money by successfully investing the capital from their existing annuity books.

And when you look at their current share prices, you could easily argue that both are based purely on the value of the legacy annuity businesses as well as some other non-annuity revenue streams.

What’s more, I think there’s a good chance that Partnership and Just Retirement will be able to take a larger share of the whole annuity market in future. In other words, a bigger share of a smaller market.

That’s because in the current market, many annuity purchasers don’t ‘shop around’ to get the best possible deal. However, Osborne has said that from now on all new retirees with a pension pot will be able to get some ‘guidance’ from a financial adviser before they decide what to do with their pension pot.

Some of those retirees will decide to go for an annuity, and will shop around for the best deal – which will often be provided by Partnership or Just Annuity.

I also think that we might see higher annuity sales in 2018 compared to, say, 2015. Right now, annuity rates are stunningly low thanks to low interest rates. But interest rates, and gilt yields, will inevitably rise at some point, and annuity rates will then rise too. (There’s normally a strong correlation between annuity rates and long-term gilt yields.) Better annuity rates should trigger higher sales.

There’s also scope for both providers to grow their non-annuity businesses. Demand seems likely to increase for ‘care annuities’ that pay an elderly person’s care costs until he or she dies. And I don’t see why both companies can’t move into the income drawdown market.

Fixed-term annuities could be another growth area. These policies are effectively a hybrid annuity/income drawdown product. Normally, you would pay out a proportion of your pension pot for, say, five years and receive an income during that period. Then at the end of the five-year period, you would receive a lump sum that you might use to purchase an annuity.

Then there are ‘bulk annuities’ for final salary pension schemes. Trustees for final salary pension schemes are expected to ensure the pension schemes have sufficient cash to meet their obligation to the scheme’s pensioners.

Final salary pension schemes can reduce their risk by buying annuities that will pay out to their pensioners until they die. Just Retirement and Partnership are well placed to win plenty of business in this area.

Invest now before everyone realises annuities aren’t a thing of the past

I highlighted Partnership as a potential investment shortly after the Budget. The share price was at 124p at that point. A few days later I bought some shares at 131p, which is a penny below where the share price closed last night.

I still mildly prefer Partnership to Just Retirement, mainly on valuation grounds. But I think the share price of both will rise in the medium term. Once it’s become clear to most that the annuity market will survive, buyers for both companies will come rushing out of the woodwork – which is why I think now is still a good time to get in.

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