Where is the product innovation post-pension freedoms?

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The announcement of pension freedoms cast a shadow over the future of annuities, with their demise widely predicted amid criticism of low rates offering poor value. But recent data from the Association of British Insurers suggests otherwise. One year on from the introduction of the freedom and choice regime, its statistics show now the initial rush to cash in pensions has died down, annuity sales have risen. In the last quarter of 2015, 21,200 annuities were sold, exceeding the sales of income drawdown products – 19,700 over the quarter – for the first time.

Many in the industry have observed product innovation, which was expected to fill the gap left by annuities, has not happened on a major scale. So, with the industry largely accommodating retirement needs with what is already available, is there any need to develop new products? Would innovation just add to the complexity of at-retirement choices? Or are people going back to annuities because the industry has not developed any real alternatives?

Certainty versus flexibility

There is no denying people like the certainty of income that annuities deliver as it mitigates the risk of running out of money if they live longer than expected. This certainty has also led to a revival in annuities during recent stockmarket volatility. At the same time, however, people like the flexibility characterised by drawdown, which caters for changing personal circumstances.

Towry head of retirement planning Andy James says annuities are still pretty much the only option for people who want a guaranteed income.

He says: “Things like investment annuities and third-way drawdown products offer some level of guarantee but there is only one ‘come hell or high water, this is what you are going to get’ type of product and that is an annuity.”

According to Aegon Ireland managing director Barry Cudmore, however, the products do not provide the access to capital and ability to adapt to customers’ changing retirement needs. Indeed, annuities have long been seen as a last resort as they lock people into a rate of income with little control afterwards.

“Things like investment annuities and third-way drawdown products offer some level of guarantee but there is only one ‘come hell or high water, this is what you are going to get’ type of product and that is an annuity”

And therein lies the problem, says Mattioli Woods consultant Karena Woodall. She says: “We all desire security and control but they aren’t always good bedfellows. Until you can answer the questions ‘how long will I live for?’ and ‘how much is enough?’ there will always be a conflict between pension freedoms and flexibility, and annuity guarantees.”

Broadstone corporate benefits director Brett Smith points out locking into an annuity has its difficulties where people need a higher income initially and a lower level later on if they have the state pension coming in, for example. But choosing investment-linked annuities with variable income means weighing up whether the investment risk and whether the cost of covering the capital is worthwhile.

Blended solutions

Putting some money in drawdown and some in an annuity enables people to get the best of both worlds. There are variations on this basic theme among providers, with some combining both elements in a single product and others promoting existing products as component parts of a wider solution.

Intelligent Pensions marketing director and head of pathways Andrew Pennie says although annuities and drawdown have always been there, people have failed to use them in the most efficient way.

He says: “People tend to stay in drawdown too long when they should probably stay in the early years, then use annuities to mitigate the risk of living too long.”

Pennie sees innovation happening more in the way existing products are used, rather than product launches.

Retirement Advantage and Partnership are in the minority of providers that have launched new products post-pension freedoms. Retirement Advantage has launched its Retirement Account, which merges a guaranteed annuity and pension drawdown in one product. The product is written under drawdown legislation, giving retirees flexibility to turn the income on and off. Meanwhile, Partnership has created its more specialised Enhanced Retirement Account, which it says provides a guaranteed income with flexibility of drawdown and an opportunity for investment growth for people who qualify for enhanced rates.

“Until you can answer the questions ‘how long will I live for?’ and ‘how much is enough?’ there will always be a conflict between pension freedoms and flexibility, and annuity guarantees”

James says while there are several ways to access annuities and drawdown, people need to be aware of the drawbacks. He says: “You can have drawdown products with annuities in them but we are mindful of them as the guarantees are expensive to provide and there is often a compromise on the remaining flexibility, such as less investment choice or access to capital.”

Another option is a deferred annuity, where people buy one that kicks in further down the line. “The downside, though, is if you buy it at 60 you might be in good health and you might have bad health at 80, so you could have got a higher income elsewhere,” says James.

Aside from the blend of annuities and drawdown, we could see greater use of fixed-term annuities in conjunction with a deferred state pension. Partner at pension lawyers Squire Patton Boggs Matthew Giles says: “You could sign up to an annuity for 10 years, bring that into payment at age 65 and it will give a higher income in the first 10 years of retirement when you have greater spending habits. Then you could get an uplift on the state pension by deferring it until age 75.”

Pause for thought

Avoiding complexity and adjusting to the new pensions environment are thought to be the main reasons why product development has been slow over the past year.

Suffolk Life head of communications, product and insight Greg Kingston says: “The regulator is still grappling with requirements for the at-retirement market and there isn’t yet sufficient regulatory stability. There is a fundamental problem with the complexity of some of the product ideas that have been floated over the past couple of years.”

Dentons Pension Management director Martin Tilley thinks advisers and clients are wary of any “new kid on the block” because of past problems with things like with-profits and structured products.

Talbot and Muir head of pensions technical Claire Trott believes because innovation can mean additional complexity, further innovation in the pensions market will focus on blended retirement options. “These are simple and tried and tested methods to provide outcomes that members want,” she says.