Annuity rates are falling and the headlines are full of dire news for pensioners, so surely now is better than ever to maximise retirement income. But are alternative annuities still being overlooked? Laura Suter investigates
By Laura Suter | Published Mar 20, 2012
Article from FT Adviser
The annuities market has come a long way in terms of development and innovation since the first annuity product was launched more than 50 years ago. While the market is now near unrecognisable from its former days and undoubtedly there is more choice, advisers jobs are far harder.
However, the broader market offers far more opportunity for advisers to show their worth. A simple move of selecting a suitable enhanced annuity over a conventional lifetime option can generate thousands of pounds of additional income for a client. Meanwhile opting for a joint life annuity over a single life one can be a lifesaver for couples.
After the advent of the first annuity there was stagnation in product development until legislative changes in the 90s brought about drawdown. Following this came flexible annuities, investment backed options, enhanced and impaired annuities and fixed term annuities.
The innovation has not stopped there, and most recently Primetime Retirement, formerly known as Living Time, brought out a fixed term annuity backed by a structured product. This offers a fixed term of six years and is written under a SIPP. But alongside the income and guaranteed maturity lump sum at the end of the term, the product offers the opportunity for some investment growth. Linked to the FTSE 100, the product will work like a structured product, offering growth if the market grows, within certain criteria.
While many advisers have been keen to embrace these alternatives to the standard lifetime annuity, many are still not doing enough and more education is needed.
The impact of the RDR on the alternative annuity market is much debated, as with all aspects of the RDR. Some say that it will lead to more specialist retirement advisers, who have clients referred from other adviser firms and are fully versed in the options available.
However, others feel that it will see a move away from those with smaller pots, putting advice out of reach for many low and middle income providers. As an explicit fee will need to be paid, rather than commission, many feel that advisers will only deal with higher net worth, who can afford to pay for the time needed to research all retirement options.
One group that believes that RDR will lead to more specialist retirement advisers, and which has already put such a model in place, is Intelligent Pensions. The company has developed financial software in order to graduate the at retirement process and receives the vast majority of the 1,400 clients it has dealt with from referrals from other advisers.
It has tapped into an emerging trend in the at retirement area, of not just selecting one annuity option, but using a raft of them alongside each other. The principal is that it is a very risky strategy to take the entire pension pot and buy an annuity with it all on one day.
Steve Patterson, managing director of the company, instead refers to it as a decade of annuitisation. “It’s a shades of grey process rather than black and white”.
Rather than selecting one annuity option and sticking with it, many advisers are now urging clients to take a pick and mix approach. By using drawdown to offer flexibility in the earlier stages of retirement an annuity can be selected later on, when ill health or simply older age will garner a better rate.
Another option is to secure the ‘must have’ income with a lifetime annuity and then invest the remainder of the pot in drawdown, enabling more risk to be taken.
Opening up the market
You cannot mention annuities and not mention the open market option (OMO). It is the campaign that has been trying to encourage shopping around and forcing customers to get a better deal, rather then defaulting to their pension plan provider.
The campaign reached a big milestone in March of this year, when the ABI published its new code for insurance providers. It now means that instead of allowing the pension provider to mail out an annuity quote complete with application form, at the retirement date, providers have to go one step further.
The code, which only affects ABI members, means that providers must highlight different options and that shopping around can get a better deal and send out wake-up packs that do not include application forms for their own annuities. The new code also means that providers must ask six key questions on the retiree’s health and circumstances, to help assess whether an alternative annuity is a better option.
While the move has been heralded as a leap forward in the system, it is by no means the end of the OMO campaign. The ABI code will not affect a large portion of the industry, namely non-ABI members and the occupational market, and many feel that the demands on insurers need to go further still.
Quotes can still be included in the packs sent by providers to retirees, which was a contentious issue when the guidelines were being drawn up. However, research from the organisation showed that it made no difference to retirees’ annuity buying if the quote was omitted. However, as Steve Lowe of Just Retirement points out, “If it offers no value to the customer, then why include it?”
The other issue with the code is the time lag between the ABI issuing it this March and it actually being put into practice. Companies have a year to implement it, until March 2013, but it seems unlikely that it would actually take companies more than two months to make the necessary changes. Whether they will actually move so quickly remains to be seen.
Another contentions issue surrounding the OMO campaign is whether it really applies to all people with all size pots.
John Lawson, head of pensions policy at Standard Life, says that those with small pots should address the issue of their retirement situation, whether they can retire yet and if they can afford to do so before they look at the best rates out there. His, admittedly biased, argument is that they will get this discussion if they stay with their pension provider, like Standard Life, but that they will not get this if they just go to a shopping around broker who assesses the best rate that can be obtained and not the suitability of that decision.
Lawson adds, “Those with small pots are only likely to gain around £1 per week by shopping around anyway. It’s more important that they get that information on retirement.”
However, Steve Lowe of Just Retirement completely disagrees, understandable considering that he comes from an alternative annuity background – a sector that benefits from shopping around. He says that it is a “lazy piece of rhetoric to say that it’s not worth it” for small pots to shop around.
And, while a generalisation, it could be argued that those with smaller pots are likely to be less well off and so more likely to be in ill health and therefore benefit from an enhanced or impaired annuity.
Another concern surrounding the OMO campaign is that it places too much focus on the best rates, with other aspects being overlooked. Standard Life’s Lawson says that while getting a good rate is important, many do not consider issues such as the financial strength of the organisation or trust in the name.
Much in the same way that those who look at car insurance quotes on online supermarkets do not necessarily select the cheapest option from an obscure provider and instead pay an additional £50 a year for a well-known name, the same can be said of the annuity industry.
Andrew Tully, pensions technical director at MGM Advantage, agrees, saying that as a smaller provider it is sometimes not recognised by consumers, who may choose to put their money elsewhere. He also argues that rather than solely focusing on the best rate, consumers need to be aware of the most appropriate option too.
While the ABI’s move on the code is an encouraging step forward, it also does not address the issue of occupational schemes, which represent a large proportion of pension pot holders. Tully adds, “Industry members think that trustees and employers will give them the best deal and do not realise the need to shop around.”
Getting the gender right
Aside from RDR, another factor that will have a big impact on the annuity market this year is the European Court gender ruling, which determines that annuity rates cannot be based on gender. Currently, annuity rates for men and women are different as they have different life expectancy and contract different illnesses.
While the fine detail of some of the ruling, which comes into place in December 2012, is yet to be clarified – such as how gender specific illness will be handled – the industry is already geared up to alter its pricing.
However, some predict that the move will lead to the emergence of more internal and external pricing, internal being the rate quoted to existing customers, while external is what it quoted on the open market.
The logic behind this is understandable. Providers know the gender mix of customers on their books and so can factor in the longevity risk of this relatively accurately, with women tending to live longer and so getting lower rates.
However, for the open market they have no idea what mix they will get and so need to build in a risk margin for this – leading to lower annuity rates.
While Tully admits that he can see why some providers would want to do this, he is “not a fan of the idea”.
This all may become a moot point, as many believing that the concept of a standard rate may be a thing of the past in coming years. An entirely underwritten process is likely, many believe, with all quotes being based on the individual’s circumstances, rather than assumptions for certain groups.
Education, education, education
More education for consumers is another key issue with which the industry is in agreement. The ABI’s new code makes some steps forward, stating that customers must be contacted between two and five years ahead of their selected retirement date. However, it adds, “We agree that the sooner customers engage in retirement decisions, the better, but we believe this is beyond the reach of the code.”
A large hurdle in the pensions market is getting people engaged. Some say providers should be doing more, approaching retirees at an earlier stage and going beyond their current remit of having to send wake up packs six months and six weeks before the selected retirement date.
Standard Life’s Lawson agrees. “As a company we need to do more further out, not just five years ahead but engaging people between the age of 20 and 50.”
Why they have not already done so remains to be seen, but Lawson argues that up until now they have relied on IFAs and brokers to educate consumers. He says that in the past five years a raft of non IFA advised customers has come to the company “from nowhere” and that this customer is unserviced. He adds that the company has not yet had time to react to this trend, but will work on doing so.
Many feel that the Money Advice Service has a role to play, acting as a central and neutral resource for information on annuities. Technology certainly can be used as a low cost option for providing information as a first port of call.
MGM’s Tully goes one step further, calling for a central resource to which all providers direct customers, with information on products, and five step guide to shopping around, example rates and a list of advisers to approach for more detailed, personalised information.
However, Jane Vass, head of public policy at Age UK and a member of the OMO working group, says that the system should be turned on its head. “The system assumes that people go through life needing to know how to annuitise when they only do it once. It seems better to have a system that moves people seamlessly into the right option.
She adds that as there are not hundreds of providers, “it’s not beyond the wit of man to link them up and offer a centralised service”.
What’s the alternative?
It is all well and good to say that alternative annuities pay more and offer more options, but just how much more can be gained by deviated from a standard option?Table 1 lists the various alternative annuities that can be purchased with a £100,000 pot, the standard rate is also shown as a basis for comparison.
Looking at the headline rates for the RPI linked annuities shows why many consumers are put off them initially, as the rate is so much lower than the standard. However, here is where advisers come into play, to really show clients how exactly that rate can grow, potentially diminishing the standard rate in later years. With inflation circling 5% in the past year, the value of these annuities is really shown.
Looking at the fixed term options shows that Aviva pays the lowest at all terms and for both genders. For the lowest paying rate for a male at five years the total payout of £104,792 represents a 0.94% AGR, pretty dismal.
When compared with the best performer at this term for a male of Just Retirement’s total return of £107,763, the impact of picking the right provider can be seen. Although Just Retirement’s 1.51% AGR is still not astounding and many would feel that they can do better themselves, through drawdown. The difference in rates between providers is also because Aviva is a household name and many would feel more comfortable putting their money with them rather than a smaller provider, but this does come at a premium.
Looking at the AGR of the annuities shows that retirees are relying on being in ill health or annuity rates having risen by the term end, as the growth on the £100,000 income is negligible at five years.
At 10 years it improves, with MetLife providing the best overall results, delivering £127,823 for a male and £126,581 for a female, or 2.49% and 2.39% AGR respectively. However, with annuity rates continuing to fall sharply, this may not make up for the drop in rates should ill health not occur.
The high costs of some products in the fixed term annuity market have hampered their success, some believe. Steve Patterson at Intelligent Pensions says that charges need to come down before more will consider them. “There are products with quite heavy expense loadings, which creates a problem in the market,” he adds.
For with profits both Prudential’s Income Choice and MGM’s Flexible Income Annuity are shown. Each one is shown at the maximum income that can be taken, the equivalent to what a level annuity would purchase with the same pot and the minimum income. While actual results cannot be shown, the Table shows the impact that taking a high level of income can have on the pot. With the maximum income taken and a 5% return on the Prudential product, the income rapidly reduces after 10 years.
What the future holds
With product innovation having come on in leaps and bounds over the past few decades, where does the annuities industry go next?
Many providers feel that products that allow for more investment growth but in a secure way will be the largest area of development, not dissimilar to Primetime’s new offering.
Peter Carter, product marketing director at MetLife, says that with people now looking at spending 30 or more years in retirement, any investment linked to an annuity needs to be considered as long term. However, retirement is not a time of life to be taking undue risk, so protection on the downside is needed.
Carter also believes that there is some mileage in creating a product that combines an ISA and a pension, offering tax relief and limited withdrawing of funds.
Long term care is another key issue in the market at the moment, with many not being adequately prepared to pay for it should the need arise. A product that allows for long term care to be paid from the pension pot could be another product development that would have direct demand from consumers.
Nigel Barlow, director of technical product development and marketing at Partnership, believes that disability linked annuities could be developed. The product could be flexible and on diagnosis of a condition the annuity could increase by 50% to 100% in order to pay for a care home. Obviously this would come at an additional cost at the outset, but as rising care costs are a constantly debated need it could well benefit many people.
Tully adds that MGM will also be creating new products this year, mainly in the fixed term area but will expand on what is already offered. He adds that consumers want flexibility of when to buy their annuity and want to do it in phases, as with selling down of equity portfolios.
Platforms, which appear to be dominating large areas of the financial services market already, could also come into play in annuities. Currently, when investors are on a platform and they annuitise they remove money from the platform, ergo it is in the platform’s interest if more retirement income options are offered that lead to staying invested on the platform.
Another question is whether more development is needed. With new products comes a move further away from a simplified market. If providers begin bringing out products with slightly different tweaks do advisers, let alone clients, have any hope of understanding all of them and their limitations?
As Carter says, “Innovation for its own sake is a bit pointless.”
Article from FT Adviser
