It wasn’t that many years ago when the only option for taking a pension income in retirement was through a traditional annuity. For example, one that remains fixed for life or escalated at a predetermined rate or in line with the retail prices index.
The reason why these were so successful and continue to make up 90 per cent of annuities sold today is that they provide a guaranteed income for life. However, like anything in life, preferences change, people want more choice and this is no different in the annuity market.
While these products still have a place for a large number of clients, people’s needs are changing. Many people are living longer and will require an income in retirement for much longer.
Many are also seeing the rate of inflation as a danger to their future income. So it is no surprise that there are many other solutions that may better suit a client’s need in retirement. But are they being explored?
Over the past few years, as life expectancy has increased, providers started to look at investment-backed options and enhancements for impaired lives. Even over the past year there have been further developments, with the birth of third-way products in the UK market.
These developments appear to cater for the changing needs of the consumer and it is important for clients, advisers and trustees to pay close attention to the open-market option.
Why? because there is a concern that half of those approaching retirement or having retired are not aware of the Omo and 48 per cent of people in the UK don’t even know what an annuity is.
Some would say that choosing an annuity is the most important financial decision that someone has to make, yet the fact that people do not know what an annuity is, clearly demonstrates the need for more education.
The industry must ensure that the clients’ needs are best met both by the product and rate, especially as the difference between the best rate and worst rate in the market could be in excess of 10 per cent.
The concern is that with 90 per cent of annuity business still being written into traditional annuities, are we certain that all the options were fully explored with these customers prior to purchase?
Don’t get me wrong. Conventional annuities still have a huge part to play in the market as not all the options available to customers will be viable. However, are all 90 per cent ideally suited to this type of product?
Even advisers are now starting to question the value of conventional annuities. Our research shows that more than 50 per cent of advisers believe that conventional annuities do not provide sufficient value for their client’s retirement. Added to this, some 90 per cent of advisers consider inflation to be a risk for clients buying one of these annuities.
We did some research which highlighted that people approaching retirement age would want to carry on working and keep an active retirement. Today, retirement is active rather than shutting down, which is all contributing to a healthier lifestyle, which will impact on their annuity decision.
This view is highlighted by psychologist Martin Lloyd Elliott who says: “While the modern society is apparently so biased towards youth culture, a more radical and transformative change has occurred among the over 50’s that leaves teenagers lagging behind. Today, 50 is closer to the middle of our life than to its end, with many economic and psychological factors bringing this change. Psychologically, there has been a shift from a closing down expectation for the second half of life towards a much more optimistic ‘opening of new doors’ spirit of good times ahead”.
You only have to look at the statistics we have compiled to illustrate just how people’s lifestyles are changing.
For example, the amount spent by the over-50s on travel has increased six-fold over the last 50 years. There has also been a fourfold increase in the time spent on sport and exercise.
Today, 65-year-olds spend more time shopping than the 16-24 age group and spend twice as long as they did 50 years agoDivorce rates have also risen significantly faster among over 50’s than any other age group in the last 20 years.
Longevity has increased. For a male aged 60 today, he will most likely die age 90. We are on the cusp of spending as long in retirement as we do our working years.
These are just a few examples, though it shows the fact that the world of retirement is a different place to what it was 50 years ago.
As a result, providers have had to develop products that meet the needs of the 21st-century retiree.
Another significant factor, which has driven providers to look at alternatives to conventional annuities, has been the demise of the traditional annuity rate.
However, rates have been on a steady increase since the start of the year, so it will be interesting to see if this trend continues. Many commentators are suggesting to buy now while rates are high as they do not believe this trend will continue.
So how can the industry meet these new demands?
The primary role for us all is one of education. We need to understand the needs of the consumer and present solutions that meet those needs. OMO is perceived as getting the best rate but how do advisers go about this, is it as simple as getting the best rate from somewhere like the Exchange?
What happens if the client has medical conditions that would give impaired terms or a lifestyle, such as smoking that can obtain an enhanced rate.
An adviser may be sat there thinking, well, that’s fine too because I cover this in my fact find, although would this have included considering impaired terms on a with-profits annuity, which if a 5 per cent ABR is selected, could give you more than 10 per cent income than the best impaired rate.
So what appeared a straightforward solution to solve a clients need for maximum income becomes slightly more complicated. This is before clients’ need for guarantees, flexible incomes, access unit-linked funds and death benefits have even been considered.
The point is that this was once a straightforward area of advice. It has now become a more complex area due to the changing needs of the client and product providers trying to meet those needs.
In the last few months, the market has seen companies from the US such as AIG Livingtime, Metlife, The Hartford and Lincoln Financial Group enter the retirement income market.
These are in addition to those products that already exist – with-profits annuities, unit-linked annuities, Prudential’s flexible lifetime annuity and Canada Life’s annuity growth account.
Each one of these options has different product features that make them unique. All these need to be understood to assess which product best meets the client’s ongoing needs throughout their retirement.
There’s no doubting that the third way definitely has a place in the UK retirement market although most clients will not be able to access many of these products due to the high, minimum premium entry levels – typically 50,000.
This effectively rules out about 91 per cent of the UK market as the average pension fund available is only about 24,000.
But for those clients with less than 50,000, there is still an alternative and that is a with-profits annuity.
With some companies offering them for pension funds as low as 5,000, this is an obvious alternative to traditional annuities. Not just because of the low pension fund entry levels, although they require some acceptance of risk by the client, but because they also include minimum income guarantees. They can be arranged for a client so that they are no or low risk. For example, 0 per cent ABR, where the starting income is guaranteed not to go down. If the client is willing to accept some risk, a 5 per cent ABR can be selected, where the income could fall if future bonus rates drops below 5 per cent.
Consumers want a steady income in retirement and not huge fluctuations from month to month, which is what they would typically find with a unit-linked contract. With a WPA, not only does the income stay the same for each individual year but also at the end of that period – end of each year – the fund performance is smoothed, thus avoiding any big income fluctuations.
Another key advantage of a WPA is that it provides a natural hedge against inflation. Inflation can have a hugely damaging effect on a fixed income. Even at low levels, say, 2.5 per cent a year, the customer’s income would reduce to almost half over 20 years.
The retirement market has already seen some sociological and economic change and this will no doubt continue, especially with the introduction of innovative products coming into the market.
However, the market is still dominated by traditional conventional annuities, which is why advisers need to understand how the likes of with-profits, unit-linked and the third way all have a part to play in their client’s retirement portfolio.
The importance on the annuity advice process is integral to ensuring that the client gets the right product for their needs. If customers are only getting information on rates, how will they know what the most suitable product is, given that they are only getting half the story?
This is one decision that customers can’t afford to get wrong. If they do, they are stuck with it and there is nothing that the adviser or provider can do. It’s time for advisers to look at the alternatives and provide customers with more choice that meets their needs rather than looking at who is offering the best rate.