Fall in bond yields and proposed new EU rules contribute to rush, pensions experts say

Workers nearing retirement are rushing to buy annuity plans before they tumble in value, pension experts said today, adding that a collapse in bond yields and proposals for tough new EU rules had led to the spike in demand.

Annuities, which guarantee a retirement income for life, are expected to start falling after a period of calm in the market once insurers include the costs of the sharp drop in bond yields over recent months.

Hargreaves Lansdown, the UK's largest independent financial adviser, said rates have "marginally fallen in the last few weeks" and falling gilt yields "could see sliding rates gathering momentum".

Nigel Callaghan, pensions analyst, said: "The surge in the stock market has seen many people bringing their retirement plans forward. Investors are nervous about fund values falling again and want to take risk off their retirement table."

The Financial Services Authority (FSA) also warned that annuity rates will be hit by new EU rules governing how much capital is set aside by insurers to cover annuities, which industry analysts believe could push values down by a further 20%.

Jon Pain, the FSA's managing director of retail markets, said at a pension summit on the weekend that the demands from Europe for a "liquidity premium" would force insurers to increase the price of annuities, which in turn would dramatically cut their value to customers. He predicted severe damage to the industry unless it succeeded in its lobbying efforts to head off the EU Solvency Directive, which is due to take effect from from 2011.

He said: "The directive poses a significant risk for the pensions market. The nub of the issue arises from the question of whether the legislation will allow firms to continue to take into account a liquidity premium in capital provisions for annuity business. In simple terms, if the implementing legislation does not allow for it, annuity providers are likely to have to significantly increase the capital they hold and as a result increase the cost to consumers."

A concerted lobbying effort by the Treasury, the FSA and the Association of British Insurers has so far had little effect on opinion in Brussels. EU officials have little sympathy for implementing exclusions that would support private sector annuity providers, including Prudential and Aviva. Most continental countries are untouched by the directive. They provide the bulk of their pensions through state guaranteed pension systems that pass solvency tests without the need for extra capital.

The Association of British Insurers recently warned that the industry would be crippled by the amount of capital annuity providers would have to hold if the Solvency II proposals went through. It said the amount could equal the current market capital of the entire industry.

The benchmark annuity rate for a 65-year old man with a £100,000 fund has remained at £7,171 a year since July. According to Hargreaves Lansdown, the rate, which strips out indexation and a widows pension, has begun to fall in recent weeks as gilt yields, which were at historic highs in the months following the collapse of Lehman Brothers, fall further.

If the EU's solvency directive remains intact, annuity rates could drop below £6,000. Some insurers have indicated they would pull out of the market altogether if the directive went ahead, because it would result in a collapse in demand from consumers.