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A few points in favour of retirement alternatives

I read with interest Harry Katz’s recent article on variable annuities or third-way products. He presents a cogent argument in a number of areas but I feel that it only right to put the other side of the argument to ensure a fair balance.

The article makes a number of points about value. While comments are often made about the overall cost of third-way products, it is seldom remembered that most of these costs are also incurred under an unprotected drawdown contract.

What third-way products offer is an additional benefit – a guaranteed minimum level of income and death benefit – for a defined fee. Whether this fee is viewed as reasonable is a subjective judgement for individuals.

I believe clients receive value in four key areas. First, the certainty of knowing the minimum level of income they will receive for the rest of their life. This may well increase, but it will never go down.

Second, the peace of mind that comes from not having to worry when equity or bond markets are falling. How do current holders of drawdown contracts feel at present with wild swings in equity markets?

Remember that the benefits of pound-cost averaging while you are saving work against you when withdrawing income.

Third, the benefit of avoiding making investment decisions with your heart over your head and switching out of markets at the wrong time – such as now – and failing to benefit from recovery when it comes.

Finally, the benefit of not having to “lifestyle” – that is, move away from bonds to equities – with potentially deleterious effects on performance over a long time period.

Some might argue that conventional annuities provide all these benefits as well. To an extent that is true but this overlooks the fact that inflation can have a significant effect over 25 or 30 years on the standard of living.

Drawdown also provides a client with time to consider the right option. Retirement is less of an event these days and more of a process with people reducing their work and income rather than stopping completely. As such, making an irrevocable decision on purchasing an annuity at an early stage of the process may be inappropriate for some clients.

Mr Katz’s article states that you will never get any increase in income due to the high rates of return required and the fact that stock markets have gone sideways for so long.

We looked at our product and backtested this against the market for different portfolio constructions over the last 20 years.

Over a period of 15 years we saw an average increase in income of 3.1 per cent for a portfolio made up of 60 per cent equities and 40 per cent bonds and 2.6 per cent if the portfolio was 40/60.

More to the point, with our new version to be launched on October 20 these figures became 3.5 per cent and 2.8 per cent respectively.

We also looked at the impact of the charge for the guarantee. Under our new version we found that clients received the same level of average income against an unprotected drawdown contract even allowing for the charge for the guarantee. Of course, the guaranteed drawdown had less variability in outcome and thus provided greater certainty to clients.

The question is raised as to why anyone would want to consider taking out a variable annuity prior to vesting. There are three basic reasons: to protect the income you can gener- ate from the current fund value; to lock in any growth over the period to increase future income; and to avoid having to move away from equities prematurely to reduce risk.

The reason that many clients’ risk profile changes at vesting is because they cannot afford to risk their income. By providing a guarantee for that income we go a long way to mitigating that issue.

As to the lack of choice in funds, we provide over 100 funds to choose from which enable IFAs to construct a variety of asset models to meet specific client needs.

We recognise that these products are not for everyone, but we do believe they are right for some.

Choice and innovation in the market should be welcomed, but if IFAs choose to ignore these products to the future detriment of their clients then I won- der who needs to be considering their professional indemnity insurance.

Finally, Mr Katz wonders how well the “American providers” have fared. I cannot speak for the other firms but we have been extremely pleased with our progress since we came to the UK in 2005, not only in sales, where we have proved that these products have a place in the market (indeed September 2008 was a record month for us) but also in the awards we have won for product innovation and service from IFAs who have welcomed what we bring to the market.

Michael Rudge

Managing director UK,

Hartford Life

Canary Wharf

London

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