systems in the UK
November 2011
Pete Ryan, Sapiens
Table of content
The future of annuity administration systems in the UK ... 2
Traditional annuity systems ... 2
Changes to annuities in over the last decade ... 3
The future of annuities... 4
The future of annuity administration systems in the UK
The annuity product sold both as a retirement vehicle and as a pure income product has historically been one of the most stable product types sold in the UK life and pensions market. This has been reflected in the nature and level of administration systems support provided to the market in the UK. Annuity administration support has traditionally followed one of two standard templates: either additional functionality built into a cover-all life and pensions administration system; or smcover-all, in-house systems, built as an adjunct to an off-the-shelf payroll system.
However, the last ten years has seen increasing pressure in the way annuities are sold and administered in the UK. The introduction of asset-backed annuities and third way annuities has increased the breadth of choice available to annuity purchasers. Increased legislation (the pensions act of 2004, Solvency II, RDR) have added pressures to the way annuities are administered. And a future in which the underwriting and pricing of annuities is expected to become more individual points towards even more change. From an annuity provider’s perspective, it is clear that the existing approach to administration systems provision is no longer appropriate or capable. This paper looks at the nature of the pressures on the annuity market and how modern annuity administration systems need to adapt to react to those pressures.
Traditional annuity systems
Historically system support for annuity administration in the UK has followed one of two templates: annuity functionality built into one standard life and pensions administration system, or smaller in-house models allied to payroll software.
The first model is a legacy of the extensive import of North American based administration systems in the 80s and 90s (e.g. CAPSIL, Life70), where the annuity product is simply considered another life product and, in the case of retirement annuities, the accumulation and payment phases are different elements of a single product. In a clear case of existing systems directing design for future business solutions, subsequent UK based systems incorporated this approach (e.g. Unisure, Lamda).
There are advantages to this model. For one, the basic new business set-up and subsequent payment administration of traditional annuity products can easily re-use those processes and functions already in place for non-annuity life and pension
products. In addition, product features such as guarantees and indexation can be adapted from similar features in the non-annuity world.
The biggest variation from the standard L&P income payment product structure in the traditional model is the regular payment and calculation of tax. The need to track different PAYE tax codes, to manage different tax regimes and to produce standardised HMRC returns are all unique features of annuity products.
Most L&P administration systems have dealt with this issue through the use of interfaces into standard payroll systems, rather than attempt to build the complex payroll functionality into the administration system itself.
This leads us onto the second model, the in-house system allied to an off-the-shelf payroll model. This takes the basic premise that annuities are essentially simple single premium income paying products and, if a separate payroll system is required, it is cheaper and quicker to build independent in-house systems rather than extend the main L&P administration system. This model has been used extensively throughout the UK. Both of these models worked well within the assumptions of the traditional annuity world, where the annuity product is simply priced, has little post day one administration, is subject to standardised tax regimes and is sold through limited distribution channels.
Changes to annuities in over the last decade
The assumptions of the traditional annuity world were significantly challenged during the last decade.
Starting with the 2004 pensions Act, a number of changes were made to retirement legislation that expanded the complexity of the annuity market. A-Day introduced a range of new annuity options for retirees including short-term annuities, value protected annuities and flexible annuities. In addition, the tracking of Personal Lifetime Allowances, the increased flexibility in retirement ages and a re-definition of the role of a dependent were introduced, all increasing the level of information required by any annuity administration system. Beyond A-Day, the market has seen a further expansion of the choice of annuity available to the would-be purchaser, from asset backed annuities through to the recent third way annuities. Annuity systems are now expected to support a much wider range of product and product options than ten years earlier.
A wider product choice allied to an increasing awareness of the open market option has meant an expansion in the role of the advisor. Despite being available since 1978,
notification of OMO rights to retirees was only made compulsory in 2002. This has led to advisors requesting increased and more detailed information from the insurer, and thus the administration system. Illustrations and quotations are now expected in real time through insurers own websites or portals. Annuity administration systems must now be able to integrate with a number of distribution channels and sales functions.
The last decade has also seen a series of consolidations of long term insurers in the UK market. From 297 FSA equivalent approved long-term insurers in 2004, there are now 129 FSA approved long-term insurers (source: ABI Key Facts). This consolidation trend has resulted in many insurers operating several distinct books of business, throwing up the twin issues of maintaining a single point of contact with a multiple policy owning client and the necessity to provide multi-company accounts separation.
One thing that has become evident over the last decade is that the traditional systems model for administering annuities is under increasing pressure. Wider choice, larger data requirements and an increased need for integration into a wider IT infrastructure are all challenging the current model.
The future of annuities
Over the next five years, the annuities world will be impacted heavily in five major areas: Increase in size of the annuity market
Pricing of annuities Distribution of annuities
Governance and taxation
An increased demand for annuity flexibility
The most obvious change is the increase in the size of annuity market. The annuity market has tripled in size over the last 15 years in the UK (ABI Research Paper: Pension Annuities) and there are several reasons for expecting this growth to be maintained into the near future:
The population expansion of the 1950s is now attaining retirement age
Defined benefit schemes are rapidly being replaced by defined contribution schemes
Auto-enrolment should increase the number of individuals contributing to pension schemes in near future (currently this figure is below 50%, so there is plenty of scope for increase)
In terms of administration systems support, this rapid growth in annuity provision means that the older, in-house systems will, for the most part, be incapable of the necessary scaling required. Future annuity systems must be able to administer larger volumes of business without any noticeable reduction in performance or accuracy.
The second major impact on the future of annuities will be in the area of pricing. Solvency II will have an immediate and direct impact. From 2012 life companies will no longer be able to use corporate bonds to value their annuity liabilities, but will be obliged to use government gilt rates. The amount payable under a guaranteed annuity will inevitably fall as a result of this. In addition to the Solvency II impact, the recent ECJ gender equality ruling will remove the traditional gender differentials in annuity pricing. These changes, allied with continuing uncertainty around the rise of life expectancy in the UK, mean that the traditional mechanisms used to price annuities are no longer valid. It is almost certain that the industry will move towards the kind of ‘post-code’ pricing approach beginning to be used in the General Insurance sector. Ultimately, the industry is moving towards fully underwritten and individually priced annuities, where the price is based on a number of lifestyle and genetic factors. This move towards individualised pricing is evident in the booming demand for impaired or enhanced annuities.
In terms of systems administration, this move towards individual pricing changes the way in which annuities will be quoted and written. Systems will no longer be able to rely on table based annuity rates, but will need to be able to access flexible rating engines, in much the same way that general insurance models currently work.
The distribution of annuities has changed considerably over the last ten years already, but the advent of the Retail Distribution Review may well bring about further changes. Annuities lend themselves to an advice based model, given that the purchase of the annuity is a single transaction. The issue of indemnified payment of commissions is not really relevant to annuities.
Any future annuity administration system must be able to support advice based remuneration, or at the least, be capable of integrating with future advisor compensation systems.
The governance and taxation of annuities are subject to some major changes over the next five years. Solvency II not only has a major impact on the pricing of annuities, but
will precipitate an increase in the depth, detail and transparency of the governance of annuity books. Any annuity system must be able to provide atomic detail of annuity pricing, premiums and payments for use in post Solvency II valuation models.
The Real Time Information (RTI) legislation will change the way in tax returns are generated for annuities. New interfaces via BACS through to the government gateway will be required, and there will be an increase in the flexibility required for generating these returns. Any annuity system must have both the capability to integrate with the prescribed interfaces and the flexibility to report according to the individual scheme’s rules.
Finally, beyond the four points mentioned above, it is not a stretch of the imagination to see annuity administration following the wealth management model into self-administered functionality, whereby clients have instant access to their annuity information via a web portal. In the case of asset backed annuities it is likely that clients will want to manage their annuity investment on a day to day basis, selecting from the vast range of funds currently available on wealth management fund supermarket platforms.
One result of people living longer is that retirement is no longer a simple, predictable event. People will have different needs from their annuities at different age. An active 65 year old has different annuity needs to a care supported 85 year old. As such any annuity system of the future must able to support flexibility in the definition of annuity; it must able to schedule different payment levels for different ages with different options becoming effective at different ages.
Annuity administration systems for the future
So where does all the above leave the annuity administration system? It is clear that the volume and rate of change of the annuity business models has far exceeded the comparative change in the support annuity administration systems. And it is just as clear that this discrepancy will continue to grow if the current models for annuity administration systems continue to be used.
A new approach in systems support being required to keep track with the burgeoning annuity world. This model must embrace many of the functions already prevalent in the general insurance world but without compromising the very nature of the annuity product as a long term insurance product. It must be able to provide the security and stability of the existing life and pensions systems, with an increased focus on the traceability of
data. But at the same time, it must be able to provide the agility and flexibility needed to provide rapidly changing annuity products that may well be priced and designed on an individual basis.
In summary, the annuity administration system of the future must have the following features:
A component based architecture – it must be easy to integrate the annuity administration engine with the range of external and internal interfaces and components that will be relevant in the future. The new model must be able to integrate with HMRC interfaces, client and broker portals in addition to internal systems such as enterprise General Ledger, Client Relationship Management systems and Calculations Engines
One of the components of the new model should be an agile pricing capability that enables individual pricing – most likely integrating with a dedicated rating engine
In addition to the rating engine, the system must either contain, or interface to, an agile calculations module that is able to react to and reflect flexible charging approaches
It must have the capability to either offer, or interface to, a wide range of asset classes (such as cash based, equity based, guarantees etc) in order to support new world asset backed annuities
Scalability – any future model must be capable of scaling considerably to support the anticipated increased in the annuity market going forward.
Well defined data models – it must be possible to identify data at atomic levels for use in Solvency II actuarial models.
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The information, content or material herein is provided "AS IS", is designated confidential and is subject to all restrictions in any law regarding such matters and the relevant confidentiality and non-disclosure clauses or agreements issued prior to and/or after the disclosure. All the information in this document is to be safeguarded and all steps must be taken to prevent it from being disclosed to any person or entity other than the direct entity that received it directly from Sapiens.
