Industry experts have branded unit-linked guarantees “almost criminal” and called on the FCA to investigate whether the products represent value for money.
Unit-linked products, commonly known as guaranteed drawdown, have been touted by providers since the 2014 Budget as a way to offer both guaranteed income and flexibility.
But Aviva head of pensions policy John Lawson says after charges are taken into account savers are unlikely to benefit, and warn: “these products only give value to the people to who run them”.
Pensions Institute director David Blake, who is leading a review into pensions market for the Labour party, agrees while customers are attracted to steady, flexible income, “they don’t seem to realise the expense”.
He says: “People are being seduced by flexibility and guarantees but not realising they are paying really high charges.”
Blake is calling on the FCA to conduct a wide-ranging market study on the true costs of unit-linked guarantees.
So should advisers be concerned that alarm bells are being rung over unit-linked guarantees? And is the claim that the market should come under the regulatory spotlight a valid one?
Taking the third way
Although popular in the US, unit-linked guarantees have been regarded as a niche product in the UK.
But since the freedom and choice reforms were announced last year providers have revamped their offerings. Now the three main providers – Axa, MetLife and Aegon – report growing interest from advisers.
In a report on unit-linked guarantees earlier this year, Retirement Intelligence director Billy Burrows argues the products form a “strong proposition” where “the certainty that the future pension fund will either purchase a certain income or provide a minimum fund value is important”.
He says: “Their strength is evident to people like me who have wrestled with the annuity/drawdown conundrum where many clients want the best of both worlds; guaranteed income for life and pension flexibility. There is no product other than a version of a unit-linked guarantee that provide both of these in one policy.”
The products are essentially a mix of equities, bonds and cash with an insurance policy overlaid which guarantees the level of income or capital. Consumers can choose to guarantee income, capital or both. Policies have a guaranteed death benefit attached that pays out the higher of either the value of the plan or the amount invested, less payments already made.
There is also the ability to lock in investment gains. Funds values are typically reviewed once a year and used as the new base to calculate the level of guarantee. The idea is income can only go up, and never down.
But Lawson says once fees are factored in, “the chance of outperforming the equity risk premium is not only negligible, it’s nil.
“Some unit-linked guarantees are almost criminal, the charges are so high there is little potential for upside.”
Product fees are made up of the product charge, fund management charge, and guarantee charge.
For example, clients using MetLife’s guaranteed drawdown option will be charged between 0.5 per cent and 0.7 per cent depending on the size of the investment, 0.54 per cent for fund management, and a guarantee charge of either 0.95 per cent or 1.2 per cent depending on the value of the locked-in fund.
Lawson says: “If advisers are thinking they’ll invest in these products because they give better long-term returns than an annuity then they’re kidding themselves.
“On a year-by-year basis you might outperform, but over the long-term based on historic equity risk premiums you’ve got no chance of outperforming an annuity. The only real benefit of going into this is you might have freedom to come out again, unlike an annuity.
“But if you’re going to do that, why not invest in cash? Without all those insurance charges and fund management charges, why not just have cheap straightforward cash deposits at the best rates available?
“These products only give value to the people who run them, with no value to the customer at all. I honestly don’t know why an adviser would use them. Providers are saying there’s a lot of interest in them but I don’t think that’s true.”
Figures from consultancy Towers Watson show premiums written reached a peak of £1.4bn in 2012 before dropping to around £900m in 2014.
The Blake review
Blake’s review of pension products is due to report in the summer. He will not say whether unit-linked guarantees are in the scope of the report, but warns it is difficult to see the “real costs” of the products.
He says: “Customers want flexibility and guaranteed income. But what is not transparent are the costs. In particular, using derivatives to create those guarantees and long-term options are incredibly expensive.
“There should be a campaign for the regulator to do a market study on these costs.
“I’m very much in favour of competition and transparency. The whole point about competition in a free market is knowing about pricing in order to see whether you have value for money.”
Providers are adamant the products are sufficiently transparent and do not merit a regulatory investigation.
MetLife UK wealth management director Simon Massey says: “Traditional providers are continuing to promote last century product solutions in a post-pension freedoms environment because they have not been able to come up with new innovative propositions.
“Our consumer research tells us customers are worried about running out of money, flexible access and, if possible, leaving some legacy. Our products satisfy those needs.”
Axa Life Invest UK says says critics misunderstand how unit-linked guarantees work.
Managing director Simon Smallcombe says: “There isn’t anything in the market that isn’t clear to clients in terms of the upside. Our portfolios over the year have averaged 11 per cent; I don’t think that shows the little potential for upside. That’s locked-in for the client’s lifetime.
“For instance, if you had three years of strong performance, we would cap to that performance every year and take a snapshot of your unit-linked value on the policy anniversary. And then if you have three years of poor performance just before you retired, we would base your income off the highest locked-in amount.”
Aegon’s guaranteed products are manufactured by its Irish subsidiary.
Aegon Ireland marketing director Duncan Robertson rejects claims that these are complex products offering poor returns.
He says: “We invest in very straightforward and controlled volatility managed funds and we don’t use derivatives. Our volatility controlled funds were launched 18 months ago and the performance has ranged from 4.2 per cent to 6.5 per cent per annum. Over the same period the FTSE did about 4 per cent.”
I first came across unit-linked guarantees in the days of Hartford Life when they were called ‘variable annuities’ or ‘third way products’.
The strength of the proposition is evident to people like me who have wrestled with the annuity/drawdown conundrum where many clients want the best of both worlds; guaranteed income for life and pension flexibility. There is no product other than a version of a unit-linked guarantee that provide both of these in one policy.
There is a lot of detail, not only in the complexities of dynamic hedging but the associated costs. The process of dynamic hedging involves a certain amount of rocket science. On the basis consumers should not invest in things they do not understand, there is still some work to do in explain what happens under the bonnet. In my experience the costs are transparent. People may think the costs outweigh the benefits but this is different from saying the charges are not transparent.
There seems to be three distinct criticisms: in the long run unit-linked guarantees are unlikely to outperform an annuity; money might be better held in cash; and the products only favour the providers, not the investors. There are also suggestion advisers recommended unit-linked guarantees may not know what they are doing – clearly these are not balanced views.
We need to separate the strategy from the tactics. At the strategic level it comes down to a choice between certainty and flexibility, and at the tactical level it is about which particular solutions are most appropriate.
Retirement income planning is now about more than just a single product sale, and is increasingly about putting together blended solutions. It is incumbent on advisers to research all the potential solutions which may meet their clients longer term needs and aspirations.
Billy Burrows is director at Retirement Intelligence