If you believe something new is happening in investment, lie down in a dark room. In investment, we simply shuffle the risks and rewards around but if you believe that we are better at this than our ancestors, I reckon your faith is unjustified by experience.
Here is an example of back to the future. When I entered the industry in 1970, the deferred annuity was on its last legs and expired soon after. Now those smart Americans who manage billions in US retirement funds are about to bring the deferred annuity back across the Atlantic to provide whizzy new solutions for UK pensions post-2015.
The 1970s death of the deferred annuity was caused by unpredictable inflation. There weren’t any index-linked gilts available to hedge that risk, so people who saved up to buy guaranteed fixed incomes for
their retirement were shafted.
Today, you can hedge almost any risk you can think of and many people think the deferred annuity is the right product for the new era. The US version is a plan that covers both accumulation and decumulation instead of putting an arbitrary cliff-edge, ha-ha or elephant trap between work and retirement and requiring separate solutions for each, which is what previous UK legislation did.
The big issue with pensions post-2015 is that solutions must handle uncertainty. The vast majority of people will not know when they will retire, to what extent they will retire and how much income they will need when. This means conventional lifestyling is somewhere between inadequate and useless.
The US solutions will enable accumulators to purchase minimum income guarantees with all or part of their savings. The guarantees will be time-related and the more robust they are, the lower the returns they will offer. Although the plans will allow some adjustments as you go, their best use will probably be to provide a base level of income. In decumulation, the guaranteed minimum income can be started, deferred or varied.
A key issue with DAs is the cost of the guarantees. Regulators have rightly insisted that insurers hold enough capital to back such guarantees (in the 1970s and 1980s they didn’t), and this is now a major element of costs. Insurers can hedge away many risks but I expect them to apply pressure for kinder regulatory treatment. Another thing they are likely to do is to revive their demand that the Government provides a pricing reference for longevity by issuing longevity bonds.
Because their clients will be demanding proposals for maximising their pension funds, advisers will be keen to be on the front foot with solutions but, given the regulatory hurdles, solutions embodying the better features of US products may not emerge until well into 2015. Before then, I expect to hear steadily louder complaints from providers about FCA rules forming unnecessary roadblocks.
It was the FCA’s failure to police insurers’ annuity exploitation that prompted the Treasury to back Steve Webb’s proposals. So it will be interesting to see how the regulator copes with a desire for innovation based on genuine need with heavyweight political backing. Not well is my prediction. HMRC has learned to stop trying to block Treasury initiatives with bureaucratic rulemongering.
I suspect the FCA is going to learn this the hard way.
Chris Gilchrist is director of Fiveways Financial Planning, a contributing author to Taxbriefs Advantage and edits The IRS Report