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Billy Burrows: Fixed-term annuities are not annuities

The front page of Money Marketing last week led with the story ”L&G warns FSA over possible fixed-term annuity misselling”.

The General doesn’t like them but Snoopy does may be an over simplification of the excellent online comments but it shows that views on fixed term are polarised.  The first point to make is that these policies are not annuities but a form of pension drawdown. This is not just a technical difference it has really important implications for the way these policies are sold.

In one corner are those who argue that fixed-term income is not a good product for consumers because the customer may be taking more risk that is good for them and in the other corner are those who believe that fixed term provides customers with much needed and important flexibility.

A sub plot to this interesting debate is the realisation that the industry and customers are between a rock and hard place. The pension industry is in desperate need for product innovation and better solutions for their customers but is regularly accused of selling high charge and risky products.

Customers are in a difficult place because annuity rates are at the lowest levels ever and they find it difficult to make complex decisions about which options are best for their circumstances.

So how can product innovation be harnessed to provide customers with solutions that meet their needs?

The starting point is to understand what the customer needs actually are. I have written elsewhere about the 5 risks facing people at retirement. These risks are; longevity, inflation, interest rates, equities and health. The best outcome for a customer is that his income requirements are met in the future no matter happens to his personal circumstances or to financial markets.

Put simply, if someone invests in a level annuity and high inflation returns and interest rates rise, the customer will be stuck with an income that is falling in real terms. If someone invests in a fixed term annuity and interest rates rises and or their personal circumstances change in the future they will have a second bite at the cherry as they can invest in another annuity when the policy matures.

I argue that in a world where we don’t know what the future will hold it makes sense for investors to consider a portfolio of annuities or drawdown policies. I can also point to some complex financial modelling that proves the same point.

Returning to the central point of whether fixed term will be the next misselling scandal, the answer depends on the quality of advice. True the policies do transfer a lot of risk to the individual but they also provide flexibility. Providing advisers understands the risks and are able to communicate these to the customer in a way they understand there will not be any missselling.

However if these policies are sold by highlighting the potential advantages but without fully explaining the risks, there will be potential for misselling. In such situations the regulator may point out that fixed term is a drawdown sale and will look for a higher standard of advice than for an annuity sale.

As someone commenting on the Money Marketing website said “the bottom line is that the choice is neither black nor white. L&G is wrong to try to paint it so”.

Billy Burrows is director of Better Retirement Group

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Comments

There are 15 comments at the moment, we would love to hear your opinion too.

  1. David Trenner - Intelligent Pensions 14th May 2012 at 10:24 am

    Fixed Term Annuities are a huge gamble and yet they are being marketed to cautious investors. Yes they give guaranteed income for a number of years, yes they give a guaranteed fund at the end of the term, but how much that fund will buy is a complete guess.

    Given the internal rates of return these products give – typically less than 1% p.a. – a client would be better off going into drawdown with a low risk portfolio which has the added advantage that if annuity rates go up you can actually buy an annuity while they are up rather than waiting for the end of the fixed term, when they might be down again!

  2. Pensions are now the highest risk product in the market place. The name Pension should be replaced with the name Retirement Income because clients with Personal Pensions are quering the reason to convert thier fund into an annuity with another set of costs. Having saved a pot of money for retirement, they cannot understand why they cannot have this money when they retire.

  3. Since starting in this industry many years ago I have been disappointed and surprised with the lack of risk assessment tools available to the “average” adviser (tied or not).

    It must be simple to clearly illustrate the different risks in terms of percentages – how many people will benefit from enhanced annuities if they defer purchase by using the fixed term option?

    What is the typical reduction in expense requirements as you get older vs. the effect of long term inflation forecast?

    How many people “win” the so called mortality cross subsidy (it should be less than 50%, but perhaps those with bigger pots are more likely to win the gamble as these are generally better off and therefore have better life expectancy anyway so the number of clients that benefit may be quite small).

    Another example: how many Whole of Life assurance plans written on a balanced basis end up paying out and how many are surrendered before death?

    These statistics must be out there but I am guessing the knowledge would only benefit consumers and so they are not published.

    To talk about the choice between fixed term and “traditional” annuities in terms of risk you must understand what these risks are to each client and we simply do not. The only things we know are:

    they both present different risks
    and
    you are unlikely to get a complaint upheld if you arrange a traditional annuity
    and
    most compliance type people – including the FSA – don’t understand statistical risk and are happy for clients to be wilfully misled providing it fits with their view on what is “right”.

    A side note: I have only recommended one fixed term annuity and have recommended many traditional ones.

  4. Well, this has put the cat amongst the pigeons! David’s comment that clients will be better off going into drawdown ignores some of the key risks, that of interstt rates (and bond security) and equity returns, so not necessarily true.
    When I do this type of planning, it is essential to see if the income produced is crutial to their needs. i.e. if it is needed to provide food, shelter, warmth etc. If so, a conventional, indexed annuity is the right choice. Where the income is needed to provide discressionary spending money, spell out the risks as well as potential returns for each type, and let the client decide. Its not quick, must be done face to face, and requires a good deal of probing before a decision can be made. So lets stop any annuity sales through websites, or directly from pension providers, and insist that only qualified IFAs can advise in this area. I am not adverse to a specialist exam on this area, JO5 is not enough!

  5. From ChrisF they both present different risks
    and
    you are unlikely to get a complaint upheld if you arrange a traditional annuity
    and
    most compliance type people – including the FSA – don’t understand statistical risk and are happy for clients to be wilfully misled providing it fits with their view on what is “right”.

    The potential for complaint remains for conventional annuity sales. If the point of sale documentation cannot show all options were explored and reason why excluded by the adviser and client are recorded you leave the door wide open. Most clients who have purchased a fixed annuity do not understand what they have bought.
    Clients remember the good bits until they find out (at a later date) something better/safer/ more appropriate/simpler/right etc was on offer. Look at endowment complaints as evidence for this. Just recomending conventional annuity products as the client wanted no risk, is not a safe option.

  6. Most people I come across who have received stacks of paper from their former Allied Dunbar or whatever regular premium personal pension are horrified when for the first time they understand the rules – that they can only get 25% of their money back. They feel ripped off good and proper. It’s now even worse when I tell them that those with occupational and state pensions of £20K plus can have all their money back but sorry, you, with your miserable little pot of money, can only get one quarter of it back. They are livid. Look! Annuities are immoral, an infringement of human rights – a return based on money from dead people! Scrap the whole thing. Let people have their money back and let’s have rid of this stupid argument whether drawdown or annuity purchase is the best advice!

  7. Is there ANYTHING we advise on that is not subject to criticism or speculation as to whether it is suitable for investors of any risk profile?

  8. In my experience most people are capable of deciding which option is best for them when the pros and cons of each option are explored with them.

    Most of my clients go down the conventional annuity route, standard or impaired/enhanced however there are some who, for reasons mentioned above and a few others, see the potential advantage of making a temporary arrangement.

    Unfortunately the reality is that many IFA’s are not interested in the ‘average’ pension pot unless they can charge over and above the rates of remuneration typically offered by the providers to ‘occasional’ annuity advisers.

    The above can mean the client is ignored or, worse, recommended a riskier product that does ensure a better margin.

    Indeed I’ve beaten many a bog standard IFA on a standard/impaired/enhanced annuity quote only for them to change tack and recommend an asset backed product or even a drawdown.

    The net result of the above shabby tactics is usually a thoroughly confused and suspicious client that delays their purchase, often with further detrimental effects.

    I appreciate there are some good advisers out there and also that brokers are by no means perfect but we deal with annuities every day of our working lives, understand the market, are up to date with developments and fill a yawning gap in the market that is not filled, nor ever likely to be filled by generic IFA’s.

    I’d also agree with the general point that the rules are too restrictive and more imaginative/flexible access to retirement monies will help some retirees (although the vast majority will still need to convert to income IMHO).

  9. Why not give people a proper choice? An annuity or full fund refund? Stuff the £20K minimum!

  10. ‘I argue that in a world where we don’t know what the future will hold it makes sense for investors to consider a portfolio of annuities or drawdown policies.’

    The average client doesn’t have a pension pot sufficient to justify this approach.

    By using a fixed term annuity you are at least taking away one of the risks associated with draw down namely investment risk.

  11. There are a whole number of factors that could affect the most appropriate retirement income structure and if an adviser has collected enough information about their client, understands the risks involved with each option, and has communicated these effectively, the risk of mis-selling is greatly reduced.

    Without a retirement specific fact find and a retirement cash flow forecast, it will be difficult to justify a particular approach. The capacity for a fall in income must be considered and evident on file if using an option where this is possible.

    Conversely, I would expect to see that an adviser has illustrated the potential effects of inflation when recommending any retirement income option, but particularly with level annuities and when the client is younger and in good health.

    @Ken Durkin 12:22 – The option you are calling out for is Scheme Pension.

  12. David Trenner – ‘Yes they give guaranteed income for a number of years, yes they give a guaranteed fund at the end of the term, but how much that fund will buy is a complete guess.’

    If you client could get £2500 p/a for an annuity right now for the rest of their life all you have to do is run a quote through a portal using the guaranteed maturity value at the age the client would be at the end of the term. That would give you a rough idea. It is not a ‘complete guess’

  13. I think the point of Billy’s article is about suitability. There is no 100% clarity of right or wrong as a product, just right or wrong use depending on the client and their circumstances.

    As a solution they meet the needs of some people. However, if the adverts and the promotion of the benefits are to be believed then fixed term annuities will save everyone from conventional annuities.

    It is this imbalance of promotion (and those advisers who use this as a reason to select one) that I object to, not the product itself

  14. David Trenner - Intelligent Pensions 24th May 2012 at 2:44 pm

    Anon wrote “David Trenner – ‘Yes they give guaranteed income for a number of years, yes they give a guaranteed fund at the end of the term, but how much that fund will buy is a complete guess.’

    If you client could get £2500 p/a for an annuity right now for the rest of their life all you have to do is run a quote through a portal using the guaranteed maturity value at the age the client would be at the end of the term. That would give you a rough idea. It is not a ‘complete guess'”

    I have been away from the site for a few days, but could not let this pass without comment. Had you given your real name I would have emailed you directly.

    Of course you can look up the current rate for someone 5 years older, but if you compare today’s rates with those from 5 years ago you will find that they have roughly halved since then.

    Solvency II and Test Achat can only push annuity rates one way, as you no doubt explain in all of your FTA Suitability letters????!!!

    You are one of the reasons why Retirement Income Advice should be a permitted activity!!

  15. @ Ken Durkin | 14 May 2012 12:22 pm
    said:
    Most people I come across who have received stacks of paper from their former Allied Dunbar or whatever regular premium personal pension are horrified when for the first time they understand the rules – that they can only get 25% of their money back.
    ____________________

    I’m very worried if you are actively “advising” clients on pensions. They don’t “only get 25% of their money back”…. they can buy an annuity for life after PCLS..or use DD (putting aside scheme pension) and it’s not about “getting their money back” – it’s about income needs after their working life, whatever that means. Please read the post from @ Hickey

    As for Flexible drawdown pension, the reason it applies to those with £20k of MIR qualfying income (not “just £20k income) is they are less likely to need income from the state. Your method of allowing everyone all their money back negates the need to provide PIRAS and assumes they won’t just go out and spend it, leaving nothing to live on. As a taxpayer I don’t want to be forever “bailing out” your clients short of income after a few great holidays and a new car thanks !!!!

    For those able to plan for their clients, flexible drawdown pension is the best financial planning tool ever made available for pensions. e.g phased flexible drawdown pension…. great method for the right people.

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