Helping government determine the Minimum Income Requirement for annuity purchases, including for use in the 2011 Finance Bill
Submitting InstitutionUniversity of Bristol
Unit of AssessmentBusiness and Management Studies
Summary Impact TypeEconomic
Research Subject Area(s)
Medical and Health Sciences: Public Health and Health Services
Economics: Applied Economics
Commerce, Management, Tourism and Services: Banking, Finance and Investment
Summary of the impact
The Coalition government's manifesto commitments to remove compulsion in
the annuity market necessitated a decision about a Minimum Income
Requirement (MIR). Cannon's contribution to the government consultation
played a significant role in setting the MIR. Previous research by Cannon
had shown that the UK compulsory-purchase annuity market was efficient
because compulsion expanded market size (more than half of all annuities
are sold in the UK) and reduced selection effects. This research enabled
the government to justify retaining an element of compulsion. The precise
level of the MIR used in the 2011 Finance Bill was based upon the
methodology proposed by Cannon.
Research was undertaken by Cannon (at Bristol 1996-present and currently
Reader in Economics) in collaboration with Tonks (Professor of Finance at
Bristol 1995-2003) and continues up to the present (2013).
The research began in 2000 as part of an ESRC project on retirement
behaviour, when very few annuity rate data were available and the only
long data series — itself containing gaps — was for the small USA annuity
market. In 2000-2004, historical data was collected on the UK voluntary
annuity market for the period 1957-2002 showing that it was fairly priced
[b]. Further work [a] demonstrated that variations in
annuity rates were partly offset by changes in pension fund values,
showing that analysis of annuity rates in isolation was inappropriate for
valuing actual pensions. This research has now been extended to a longer
historical period for other countries [f].
After the initial publications, Cannon and Tonks were both asked by the
Department for Work and Pensions (DWP) to analyse the compulsory-purchase
annuity market, resulting in a survey report in 2006 [c], a
further analysis for the DWP in 2009 and book published by Oxford
University Press [d]. The analysis of the compulsory-purchase
market showed that pricing was efficient and suggested there was no
evidence for removing compulsion.
In the context of annuities, efficient pricing means that the expected
present value of annuity payments received by the annuitant is not much
less than the price paid for the annuity (where the difference is due to
the annuity provider having costs). The name of the metric used for
annuities is the money's worth, which should be a little less than one.
While conceptually this analysis is straightforward, it is important to
quantify correctly the considerable uncertainty in pension values arising
from having to forecast mortality improvements of pensioners. This has two
important impacts: first, empirical analysis of annuity prices could
easily draw false conclusions if inappropriate assumptions were made or if
forecasts were not updated; second, annuity providers had to price in the
uncertainty if they were not to run the risk of having too few funds to
pay out to annuitants. The effect of unexpected mortality improvements on
annuity prices was quantified in [a, c, d].
In [d], the theoretical analysis of annuities was surveyed which
showed that, if anything, compulsion overcame market failures due to
adverse selection, poor financial education and behavioural biases.
However, quantifying the welfare effect is different from asking whether
annuities are fairly priced. [d] extended existing theoretical
analyses of the utility effects of annuities by using a wider range of
utility functions. For example, the book contains the first published
analysis of annuities for a consumer with Epstein-Zin preferences. Apart
from this significant theoretical result, research also analysed the
extent to which pensioners avoid annuitisation for irrational reasons
(failure to understand annuities or psychological biases) or avoid
annuitisation to game the tax or benefits system (a form of moral hazard).
These provide good reasons for government having a compulsory annuity
requirement, as is the case in the United Kingdom.
References to the research
[a] Cannon, E. and Tonks, I.  "U.K. Annuity Rates, Money's worth
and Pension Replacement Ratios, 1957-2002" The Geneva Papers on Risk
and Insurance — Issues and Practice 29(3), pp.371-393. doi:
[b] Cannon, E. and Tonks, I.  "U.K. Annuity Price Series,
1957-2002" Financial History Review, 11(2), pp.165-196. doi:
[d] Cannon, E. and Tonks, I.  Annuity Markets (Oxford
University Press). ISBN 978-0-19-921699-4. Can be supplied upon request.
[f] Cannon, E. and Tonks, I.  "The Value and Risk of Defined
Contribution Pension Schemes: International Evidence" Journal of Risk
and Insurance, 80(1), pp.95-119. doi:
Details of the impact
The initial DWP report [c] was described by the 2006 HM
Treasury's report "The Annuities Market" [g] as "the most
comprehensive ever UK annuities pricing survey" (paragraph 2.6), resulting
in HM Treasury reiterating that compulsory annuitisation was appropriate
(paragraphs 6.1-6.2) given that annuities were fairly priced (explicitly
referring to the report in paragraphs 5.1-5.2).
Despite this, there was continued pressure from the press and some MPs to
scrap compulsory annuitisation, stoked by Fitzgerald's Brunel Business
School Discussion Paper of October 2006 "Can `Compulsory' Annuities
Provide a Fair Pension?" which suggested a large drop in the value of
annuities in 2006. Cannon and Tonks's analysis for the DWP in 2009 showed
that Fitzgerald had over-estimated the fall in the value of annuities. The
period 2005-2008 was particularly problematic for annuity measurement due
to large revisions in mortality rates from the Institute of Actuaries and
consequent uncertainty in quantifying the risk that this entailed for
annuity providers (at a time when banks were accused of being careless of
The DWP confirmed to us [i] that the research had been used:
- As part of briefing prepared for DWP Ministers in preparation for
their appearance in front of the 2009 Work and Pensions Select Committee
Inquiry into Pensioner Poverty;
- To help inform the policy debate on the abolition of the requirement
to secure a pension income by age 75;
- As part of internal briefing for DWP Ministers and senior managers on
the annuity market;
- As part of the evidence base drawn on in the DWP's strategy on DC
pensions, where the research has helped to improve the Department's
understanding of and thinking about annuity markets.
Both the Conservative and Liberal Democrat 2010 election manifestos
promised abolition of compulsory annuitisation, albeit with a caveat that
this should not result in higher state spending. The June 2010 emergency
budget announced a consultation on removing compulsory annuitisation and
led to a HM Treasury consultative document in July 2010. This explicitly
cited Cannon and Tonks noting that:
"The primary reasons for these falls [in annuity rates] are declining
interest rates (which fell from 8% to 5% ...) and increasing longevity. A
study by Cannon & Tonks concluded that the money's worth of annuities
... remained at around 90%. This represents good value in comparison with
other insurance products ... annuities remain an effective form of
insurance against the risk of outliving life expectancy." (paragraphs
In anticipation of this consultation, Cannon and Tonks wrote a letter to
the Times newspaper with David Blake (Professor of Pension
Economics, Cass Business School) and were then invited by the Prudential
(one of the major providers of annuities) to investigate the issue of
removing the annuitisation requirement, resulting in two reports published
by the Pensions Institute [e] written by Blake, Cannon and Tonks.
These reports discussed reasons for retaining the compulsory purchase
requirement drawing on our previous research. More importantly they also
discussed the appropriate level for the Minimum Income Requirement. The
second report [e] suggested that for an index-linked annuity the
minimum income should be £14,100 for an individual and £20,000 for a
The government's response to the consultation process was published in
"Removing the requirement to annuitise by age 75: A summary of the
consultation responses and the Government's response" (December 2010)
which cited the MIR calculations by Blake, Cannon and Tonks [h
paragraph 3.45]. Their methodology was based on working out the
appropriate annuity to ensure that a pensioner (or couple) received no
means-tested state benefits before the age of 100. This was based on the
observation that the probability of a male aged 65 surviving this long was
8% and that to be sure that a pensioner never received state benefits
regardless of how long they lived, would set the MIR too high. This
methodology was accepted by HM Treasury and they used the same algorithm
to calculate the MIR in the Appendix to the response document. The final
calculations were reached after an e-mail correspondence between Cannon
and Jonathan Deakin of HM Treasury [j].
Following the consultation, Trevor Gosney of the Prudential wrote to
Blake, Cannon and Tonks [k] saying that "In the Prudential's
subsequent conversations with Treasury officials they described this paper
[i.e. reference 8] as the best and most thorough assessment received
during the consultation process. As such it has played a significant role
in guiding policy decisions on this issue".
In addition to the impact on government policy, the data Cannon and Tonks
collected for [a] have been used by several sources in policy
making and the private sector (e.g. National Association of Pension Funds
[l], Aviva Investors [m]).
Sources to corroborate the impact
[g] HM Treasury (2006) The Annuities Market (London: HMSO).
[h] HM Treasury (2010) Removing the requirement to annuitise by age
75: A summary of the consultation responses and the government's
response (London: HMSO).
[i] E-mail correspondence with Imran Razvi of DWP.
[j] E-mail correspondence with Jonathan Deakin of HM Treasury.
[k] Letter from Trevor Gosney, Prudential.
[l] Letter from Mirko Cardinale, Aviva.
[m] Letter from Verenna Menne, NAPF.