you should have known about your annuity,
didn’t know enough to ask!
One of the obvious problems facing all annuitants is
understanding what they are being offered by their supplier, in this
case the Equitable life Assurance Society (ELAS)
Just before the point of contract annuitants will
have received (or should have received) a document that contained
amongst other information the following
1987, the Society introduced With-Profits Annuities and at that time
offered them with a Guaranteed Interest Rate (GIR) of 3.5%. This must
have been extremely attractive to potential policyholders though in fact
it was not necessarily in their best interest.
1996, this option was withdrawn and With-Profits Annuities were only
offered without this guarantee. At the same time the Society decided to
make changes to the GIR policies that have only become apparent recently
as this study has developed.
In addition, prospective annuitants will have received a brochure from the Society containing generalised illustrations of the historic performance of a With-Profits Annuity with different growth rates and which contained diagrams similar to the following:
The figures assume that a growth rate of broadly 6% per annum (6.0875 precisely) was anticipated such that gross payment (TGA) would remain level if that overall growth rate (ORR) is achieved.
figures assume that a growth rate of 3.5% per annum was anticipated such
that gross payment (TGA) would remain level if that overall growth rate
(ORR) is achieved.
The figures assume that a growth rate of broadly 10% per annum (10.2275 precisely) was anticipated such that gross payment (TGA) would remain level if that overall growth rate (ORR) is achieved.
charts have been copied from a document issued in early 1997 and thus
these historic figures would have been based on GIR policies. As
illustrated in the last example with the ‘Growth Rate’ of 10%, it is
important to note that at a by 1995 and subsequently the Total Gross
Annuity (TGA) was already beginning to decline as rates fell. It is at
this time that the Society replaced the GIR policies with non-GIR
policies, that is, policies without the Guaranteed Interest Rate (GIR).
The higher the ABR (TRL)
that is chosen by the annuitant, the higher the starting point of the
annuity, which is very attractive. Less attractive and not overly
emphasised is this increases the exposure to a reduction in the TGA. if
the Society reduces the ORR as a consequence of any lowering in the
growth of the economy as it moves through its cycle.
These trends are
difficult to predict and way beyond the capability of the average
pensioner. It seems that the risks that attach themselves to such a type
of investment, which is what a With-Profits Annuity is in reality, were
never clearly explained by the Society’s representatives or by the
Society itself. It is a matter of debate if such an investment were a
suitable medium for what must surely should have been a safe and secure
place to generate income for a group of people whose opportunity to
recover in the event of a financial disaster, whatever the cause, is
severely limited by their age.
at the figures and the charts, the annuitant might reasonably conclude
that an ABR of approximately 7.0% would give a combination of a high
starting annuity and some potential for growth. The decision would be
neither right nor wrong and may well depend on factors that are personal
to the annuitant.
example, if the annuitants were expecting future income from other
sources, other pensions, returns on investments, legacies, etc, then a
decision to take a higher annuity now to gain the immediate benefits,
with the inevitable risk of a lower annuity in the future, with a plan
to use the income from other sources in the future to maintain the
standard of living might be a perfectly sensible decision.
if the annuitant did not need income in the short term, maybe because
there was an opportunity for earned income in the immediate future, then
maybe a low annuity now might be a better choice.
was not explained, and arguably has never been explained, is how the
annuity system from ELAS actually works. The Society has been remarkably
coy in supplying the information, especially with respect to the Total
Gross Annuity (TGA), partly, in fairness, because the method used by the
Society is very, very complex to the point of obfuscation, but partly
because that is how the Society appears to relate to its annuitants.
Quite why the Society chose its method of computing the TGA is not
evident and to date no explanation has been offered that makes sense,
since there are easier less complex methods that give results that
parallel those of the Society. This is particularly significant since,
the method of deriving the TGA in any one year is the one most easily
used by the Society to increase or decrease the annuity actually paid.
3.2) The Equitable Life
Regrettably in order to
understand what follows, it is necessary to explain how the annuity
system of the Society works. There is a more detailed analysis of this
aspect in Section 3 but the following is intended to be enough for this
The Equitable Life
Assurance Society (ELAS) produces With-Profits Annuity - Annual
Statements every year for each annuitant and which in general contain
the following information:
Guaranteed Annuity (BGA)
Bonus Annuity (DBA)
Bonus Annuity (FBA)
Gross Annuity (TGA)
Society also produced another document and somewhat confusingly called
the Bonus Declaration for the Year Ending 31 December 19NN, which
contained references, amongst other things, to:
Bonus Rate (ABR)
Rate of Return (ORR)
Bonus Rate (DBR)
There is one other
abbreviation that must be introduced which is:
Total Return for a Level Annuity (TRL)
N.B. In the footnote to
each page is a summary of all the abbreviations used in each section as
an aid to understanding.
July, 1996, With-Profits Annuity policies contained a Guaranteed
Interest Rate (GIR) of normally 3.5% per annum which was to be allotted
BEFORE any policy bonus. The GIR is NOT a bonus. It is a contractual
entitlement similar in principle to the former GAR. All With-Profits
Annuity policies since mid-1996 are non-GIR.
GIR annuities the TRL is the ABR x 1.035 and for non-GIR annuities the
TRL is the same as the ABR.
the outset of an annuity, the annuitant transfers a sum of money, the consideration,
in exchange for a regular payment, the annuity. The annuitant
agrees with the Society in advance an anticipated rate of return (ABR).
simply the annuity is calculated using a combination of the various
interest rates, ABR, ORR, etc from the initial annuity value which is
determined by the amount of consideration money and the rates for
conventional annuities relevant to the policyholder. Each
year the Society computes new values for each element of the annuity
using two separate arithmetic series by using the ABR, TRL, DBR &
ORR in different ways, so that the series in theory diverge.
One series computes the BGA and DBA
The other series computes the TGA.
BGA and DBA are “guaranteed” under the terms of the annuity, which
is not quite what it seems, not least because these two elements of a
With-Profits Annuity do not give a constant annual guarantee. The
BGA is a reducing guarantee, which is at the rate of the ABR,
whereas the DBA can increase, remain level or increase depending on the
relationship between the ABR chosen by the annuitant and the DBR for
each year set by the Society.
Total Gross Annuity (TGA) is increased each year by the effect of the
ORR and decreased each year by the effect of the TRL. Thus if the ORR is
greater than the TRL then the annuity will increase and if the ORR is
less than the TRL then the annuity will decrease.
FBA is the difference between the TGA and the sum of the BGA and DBA. However,
the FBA is not guaranteed at all and can be withdrawn by the Society at
discussions with many WPAs, it is clear that they recognised that the
Total Gross Annuity (TGA) might go down in ‘bad years’ and then it
would recover in ‘good years’ and that the Society would do its best
to even out these variations to provide a constant level of income.
However, when the decision to make the 20% reduction was implemented, it
was immediately clear for the very first time, not only how the FBA was
derived, but that it was added at the discretion of the Society and,
much more importantly, it could be removed in its entirety by the
Society, also at its discretion with a devastating consequence on the
TGA and the incomes and lifestyles of the With-Profits Annuitants.
How the ELAS annuity works!
size of the annuity is calculated
using a combination of the various interest rates, ABR, ORR, etc from
the initial annuity value which is determined by the amount of
consideration money and the rates for conventional annuities relevant to
the policyholder. As is obvious
from the earlier charts, the annuitant then chooses an Anticipated Bonus
Rate (ABR) that meets his/ her requirements, partially advised by the
is not made clear is that within that broad constraint, there are other
rules that apply and that affect the future income of the annuitant.
table below shows a typical set of results over a period of time
reflecting the basic data. Whilst it is NOT an exact copy of an
annuitant’s data, it is close enough to be used for this report. The
TRL for a non-GIR annuity is the same as the ABR.
The GIR annuity is NOT illustrated which with this type of
annuity the TRL is increased by 3.5%. so in this chart the TRL would be
as follows 1.07 * 1.035 = 1.10745.
mentioned above, there are two arithmetic series that “control” the
total size of the annuity payments and the relationship between the
various elements that make up the Total Gross Annuity (TGA)
One series computes the BGA and DBA
The other series
computes the TGA.
3.3.1) Overall Rate of Return (ORR) in relation to the Total Return for a Level Annuity (TRL)
logic that applies is as follows:
If the ORR equals the TRL then the TGA remains constant or level
If the ORR is greater than the TRL then the TGA will increase
If the ORR is less than the TRL then the TGA will decrease
the TRL is derived directly from the ABR, it follows that when choosing
your ABR, understanding or at worst guessing what might happen in the
future will influence your decision. The ORR
is under the complete control of the Society and whilst in theory it
reflects the underlying performance of the With-Profits Fund, it lies
within the power of the Society to inflate or deflate the fund to
reflect its perceived current and future liabilities and/ or its
business objectives, none of which need be congruent with the needs
of the WPAs.
of the consequences of the GIR type annuities with the increased the TRL
is that the guaranteed element of the annuity was actually lower than it
might otherwise have been, had the “guarantee” not been offered. It
is now known that it is the un-guaranteed element that can be removed at
will which poses the question, ‘what benefits the “guarantee”
actually offers to the annuitant?’ It is also obvious from the third
chart above that as the ORR achieved by the Society began to decline
towards the middle to late 1990s, then the TGA began to decline also. It
was at this time that the GIR annuity type was withdrawn.
The Anticipated Bonus Rate
(ABR) in relation to the Declared Bonus Rate (DBR).
This is slightly more complicated in the sense that this relationship
determines what part of the annuity increases or decreases relative to a
norm. The model above illustrates a typical annuity started in 1997 and
which will be used as the benchmark.
logic that applies is as follows:
the relationship between the ABR and DBR, the Total Gross Annuity (TGA),
that is the money actually paid to the annuitant, is NOT changed.
some reason, not so far explained by the Society, in the period from
1997 onwards when the GIR and non-GIR policies overlapped, the DBR for
the GIR annuitants was set at 3.5% below the DBR for the non GIR
annuitants. (Except when the DBR was set to zero.) Why this was done is
not clear, as it had no effect on the TGA though of course the FBA was
increased and the NGA decreased.
follows that when choosing your ABR, understanding or at worst guessing
what might happen in the future will influence your decision.
is under the complete control of the Society and whilst in theory it
reflects the underlying performance of the With-Profits Fund, it lies
within the power of the Society to determine what the DBR for any year
will be, bearing in mind its own objectives which, as before, need
not be congruent with the needs of the WPAs.
example, in the last 4 years the Society has declared the DBR to be
zero. That of course may be entirely justified, but interestingly the
effect, as is clear from the above logic, is that in these circumstances
the NGA is reduced and the FBA is increased. (The second logic
statement.) The FBA is not protected and can be removed by the Society
at any time.
is conflict between the Declared Bonus Rate (DBR) chosen each year by
the Society and the Anticipated Bonus Rate (ABR). For the annuitant it
is better to have a low ABR and a high DBR. For the Society it is the
other way around. This is because when the ABR is zero, the system
pushes the money into the DBA element of the annuity, which is
protected, and when the DBR is zero, the system pushes money into the
Final Bonus Annuity, which is not.
3.3.3 The Interim Rate and the Overall
rate of Return (ORR)
The Society uses a
concept known as the Interim Rate. In any one year, the Society
announces an Interim Rate, which the Society then uses to forecast and
calculate the annuity payment, though the actual Overall Rate of Return,
which is usually different by one or two percentage points, and
announced later during the first quarter of the year is also used to
calculate the annuity payment.
The Society then goes
through an adjustment process, which is so far unexplained and in truth
seems inexplicable but it is based on the relationship between the start
date of the annuity, the interim and ‘real’ rates and the date when
the Society changes from the one to the other.
The Society has supplied several documents to annuitants which
are supposed to explain how the annuities are calculated using this so
called Interim Rate They are inconsistent with each other and in any
event, based on the interpretation used in the document, neither gives
more accurate results than the computer model nor can they be applied
consistently across all the annuities, without manual intervention.
Explanations have been requested from the Society but none as yet has
is puzzling is why the Society chose this method of computation. The
interim rate is useful for forecasting the likely payments but is not
necessary to compute the annuity payment. The argument presented by the
Society, which is that they cannot compute the ORR for 1st
January each year, is perfectly rational, so given the Society’s
fiscal year is January to December, why not choose a renewal date of 1st
of April and then apply the ORR for the next 12 months? This is the
procedure the Society has used to introduce the 20% reduction, which was
applied from 1st February 2003 and comes into effect as
annuities are renewed in the following 12 months.
in a business that in normal circumstances is as relatively stable as a
life company, the end of year financial position is, or should be, well
known in advance. There is no obvious reason why the ORR could not be
set by December based on the interim accounts and then adjusted the next
fiscal year to keep the payments in line with the actual results of the
Society. This point is brought into focus by the way the Interim Rate
and ORR are used. If it is necessary to achieve an exact ORR, the ONLY
logical explanation for a delay, then why is the ORR always set to a
whole number (10%, 13%) and never 10.12345%? The supposed gain in
accuracy from having a set of finalised accounts is lost in the rounding
3.3.4) The Overall rate of Return (ORR)
annuity paid each year is determined solely by the relationship between
the TRL and the ORR (see 3.3.3 above). What therefore is the function of
all the other elements of the annuity? Why is it necessary to have a
Basic Guaranteed Annuity (BGA), a Declared Bonus Annuity (DBA) and a
Final Bonus Annuity (FBA)? Why is it necessary to have a
“Guaranteed” and “non-Guaranteed” elements in the annuity at
does not appear to be an obvious reason. If the results are poor, then
the society can reduce the ORR and the annuity declines or if results
are good, then the annuity increases. What could be easier?
is one possible explanation. It is very convenient to have a large
amount of money allocated in theory for future payments to annuitants
that can be removed at a stroke. As this is in fact what has happened,
is this a possible explanation for the unnecessarily complex and, so far
as is known, unique structure of the With-Profits Annuity of the
The Compromise Deal
Compromise Deal was proposed by the Society as the way forward to
resolve the outstanding difficulties facing it and by implication and
amongst others, the WPAs. As an inducement to accept the deal, the WPAs
were offered 4% uplift on the BGA and DBA elements of their annuities,
(0.5% for GIRs) and 2.5% uplift on the TGA element for all WPAs
irrespective of type. (GIR or non-GIR). This took place in the fiscal
year 1st April 2002 & 30th March 2003.
Increasing the BGA or DBA only transfer money from the FBA
to these elements. The Total Gross Annuity is NOT affected
Significantly reducing the ORR at the same time of the 2.5%
uplift cancels the effect of the uplift. Of course, the reason the
Society chose to make the reduction in the ORR at the same time may
reflect other conditions that are so far neither known nor explained.
4% uplift (0.5%) definitely occurred and by implication so did the 2.5%
uplift, though it is not possible to isolate the uplift from the other
reductions taking place at the same time.
method used by the Society for deriving the inter-relationships between
the various elements of the annuity is extremely subtle and quite beyond
everyone who has not done (or might be capable of doing) this type of
analysis. And even then it is only obvious with hindsight and gained by
comparing annuities, something that was not feasible in the early 1990's
before the widespread availability of the Internet.
was surely not unreasonable to expect that the documentation included
all the information that needed to be known. But as this research
project and analysis demonstrates, it was not. The information that was
necessary was simply not presented. It is doubtful if the sales force
knew, could have known or even understood what they were offering.
The Burgess Hodgson report made clear that by the late 80's &
early 90's, the Society was in deep financial trouble. At that time, the
Society dropped the GAR's as presumably the Society began to realise
that they were not financially supportable in the long term.
The Society introduced GIR With-Profits Annuities in the late
80’s. Although it appears that this was not fully understood, the ABR,
which the GIRs thought they were choosing, was in effect their ABR plus
3.5%, in fact the TRL, and that action transferred more of their annuity
income into the un-guaranteed FBA. Arguably, an offer of a guaranteed
3.5% rate must have been very attractive to a prospective annuitant but
as it happens, it exposed the annuitant to a much greater risk in the
event that the Society decided to withdraw the un-guaranteed part of the
annuity. The GIR annuity type was phased out in 1996 for what are now,
with the benefit of hindsight, obvious reasons since it is clear that
the Overall Rate of Return to achieve a stable annuity was no longer
realistically achievable. In the case of one annuitant, in order to
achieve similar levels of annuity, the ORR would have had to remain at
approximately 11% for the last 14 years, a completely un-realistic
objective in the financial conditions of the time and today.
As the GIRs became increasingly un-marketable, these were replaced with
non-GIR annuities of the type illustrated. The DBR for these new
policies was much higher than the apparent DBR of the GIR's, which
during the parallel period was always set at the rate for the non-GIR
annuities less, 3.5%. It is understood that the Financial
Ombudsman Service and the Pensions Ombudsman are considering
if this differentiation was permissible.
4. These new non-GIR annuities have a lower TRL and thus were able to show initial steady growth of the Total Gross Annuity, as the TRL was less than the ORR, an essential pre-requisite, though by the start of the Millennium even these annuities began to show a slow decline in results.
In 2000, just before the time of the Compromise Deal, the Society
reduced the DBR to zero where it has remained ever since, further
increasing the relative size of the un-guaranteed and un-protected FBA
element and which the Society can remove at a stroke.
actions of the society raise many questions such as, why was it that:
At the very time the Society was seeking to reduce its
commitments to the WPAs in 2003 when it applied the so called “20%
reduction”, in the preceding three years it had taken steps to
increase the FBA so that it had the maximum amount available for that
purpose? You will note that in the table above, the FBA as a percentage
of the TGA increased from 15.3% to 26.5% from March 2000 onwards
DBR has been set to zero well in advance of the announcement of the
Compromise Deal? This suggests there was a clear long-term plan to
increase the un-guaranteed element of the annuity, the FBA, so that the
funds of the WPAs' could be used to meet the financial objectives of the
In the same year of the 2.5% uplift, the ORR was significantly
reduced from previous years? The effect is to nullify the 2.5% uplift,
which added nothing to the income of the WPAs and by implication
therefore cost the Society anything.
As for the future, in order to maintain a level annuity the Society has to produce an ORR of at least equal to the ABR (and implicit TRL) chosen by the annuitants. By definition this has to be at least 3.5% but for the majority of annuitants the ORR has to be at least 6.0%. This is quite beyond its current capability as, according to the Society, the funds are now invested in secure but low interest or low dividend investments. It is probable that the income for all WPAs will gradually decline at a rate that reflects the difference between the ABR chosen by the annuitant and the probable ORR that the Society might achieve.