Britain’s insurers will lose control of a market worth £15 billion a year under a surprise pension reform announced by the government, and will struggle to make up the hit to profits any time soon, according to analysts.

Chancellor George Osborne unveiled a far-reaching shake-up of the pensions system in his annual budget, aimed at boosting choice and returns for pensioners who have seen their incomes hit by record low interest rates.

For the first time, all retirees will be free to do what they want with their pension pots, scrapping a system that made it compulsory for most of them to buy an annuity, where they exchange pension savings for a regular income.

This dismantles a captive market for annuity providers such as Legal & General and Resolution, which will now have to compete for pensions business against other investment products. Their shares dropped sharply, and analysts see little prospect of a rapid recovery.

“This radical piece of legislation will destroy profitability in the highly-lucrative annuity market, in our view,” said RBC Capital Markets insurance analyst Gordon Aitken.

According to Bernstein Research, about 75 per cent of retirees purchase an annuity, with current rules obliging them to do so if their retirement savings are between £18,000 and £310,000.

After the reforms, the annuity market for individuals could shrink by up to half, the firm has forecast.

Many of Britain’s biggest insurers have been putting annuities at the heart of their business, as more Britons retire with so-called defined benefit pension schemes, rather than final salary schemes where employers are responsible for providing a guaranteed retirement income.

“There is a negative implication for new business flows in the individual annuity market, as some people utilise the increased flexibility provided by the... (government’s) proposals,” Resolution said in a statement.

RBC analysts said Legal & General (L&G) was the most exposed to annuities of the British insurers it covers, with its retirement division providing 29 per cent of group cash in 2013.

L&G generated a net £1 billion of cash in 2013.

Many large annuity providers said they could benefit from the changes in the pension rules, pointing out that the government’s budget was designed overall to offer incentives to savers, and more saving would boost the fund management and investment businesses run by the same companies.

Big life insurance groups Aviva, L&G, Prudential and Standard Life all run large asset management arms, which will also be likely to take in much of the pension cash that would have gone automatic-ally into their annuities.

But analysts at credit rating agency Fitch, which estimates the annuity market is worth £15 billion a year, said less new annuities business could mean lower profits.

“Companies offering alternative products for pensioners to manage and access their pensions would benefit. But we believe these products would typically generate lower profits than annuities,” they said in a research note.

Most exposed are likely to be specialist insurers such as Just Retirement and Partnership Assurance, both of which offer so-called enhanced annuities to people with lower life expectancy.

“These two companies have grown fast, taking a large share of the rapidly-developing market for enhanced annuities.

“The proposed reforms could seriously threaten their growth prospects and potentially lead to a signi-ficant reduction in their business,” the Fitch analysts said.

The enhanced annuities market represented 28 per cent of all annuity purchases in the last three months of 2013, up from two per cent in 2003, the Association of British Insurers said.

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