Chancellor George Osborne stunned Britain's pensions industry in March when he announced the rule change, the biggest reform of pensions in a generation to give savers a choice on how to use money saved during their working lives.

The Bank of England's supervisory arm, the Prudential Regulation Authority (PRA), said it was holding talks with life insurers whose annuity sales were their "unique selling point" as other parts of the business are under pressure.

Sales are likely to be significantly and permanently reduced, BoE director of life insurance Andrew Bulley told a meeting of parliament's all-party group on insurance and financial services on Tuesday.

Life and pensions group Legal & General said after Osborne's announcement it expects the individual annuities market to shrink by around three-quarters after the new measures come into effect next year.

"Insurers and the PRA are currently assessing the likely impact of the changes - we are having many conversations with insurers on this," Bulley told the lawmakers.

Significant potential issues include whether the viability of existing business models will be affected, spotting risks in new products companies may have to devise, and the potential for mergers among insurers giving rise to new risks, such as a clash of company cultures, he said.

Nigel Wilson, chief executive of Legal & General, told the meeting the annuities market would halve this year to 7 billion pounds and halve again in 2015, with longer-term consequences for the sector's investments.

Six insurers said last December they planned to invest 25 billion pounds in transport and energy projects, but Wilson said shrinking annuities would diminish the industry's appetite for such investments.

Insurers must match their assets and liabilities but if they have fewer annuities to pay out on, they have less need to invest in matching long-term assets like infrastructure.

However, Wilson told Reuters after the meeting that the industry will easily achieve the initial 25 billion pound target.

European policymakers are looking to insurers to invest in infrastructure as traditional sources of money such as banks focus on complying with tougher capital requirements.

Bulley said that while it was up to insurers to decide on their business models, the PRA will consider what actions the companies must take to mitigate new risks.

Friends Life Group said in May it was expecting a 50-70 percent decline in industry annuity sales and it would create new investment products to woo retirees.

"For many life companies, reacting to a new and fundamentally altered strategic and business landscape will be the key challenge over the next few years," Bulley said.

Big British life and pensions companies also include Aviva, Prudential and Standard Life.

Asked if Britain's insurers were in reasonable shape to meet tougher European Union capital rules known as Solvency II from 2016, Bulley replied they were "overall, as well as can be expected".

(Reporting by Huw Jones; editing by Pravin Char and Keiron Henderson)

By Huw Jones