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It’s a living thing

Hartford Life marketing and distribution managing director John Enos on why living benefits could be a £20bn a year market and the implications for advisers.

The first six months of 2007 have been notable for the introduction of “third way” products that chall-enge the status quo in the pension market.

In challenging the belief that clients have to choose between the stability but low investment growth potential of an annuity and the investment growth potential but higher risk of income drawdown, the debate is wide open as to how advisers can help provide a retirement income for their clients.

As the baby boomer generation approaches retirement, concerns over the way they save for their retirement are growing. The question many of them are asking is: “Which will last longer, me or my money?”

The face of retirement itself is changing. Our research shows that less than a quarter of over-45s in the UK see retirement as stopping work completely. Instead, people want to work part-time or switch to less demanding roles and if the way in which we retire is becoming more flexible, it is clear retirement products must meet these requirements.

Our survey also revealed that 55 per cent of over-45s say they would be prepared to pay an additional fee for a pension guarantee that locks in investment gains.

By doing so, they would be guaranteeing a retirement income while allowing themselves the opportunity to benefit from stockmarket gains, effectively enjoying the best of both worlds.

So, if consumers have been telling the market that they want change, why has it been slow in coming?

Cazalet Consulting recently reviewed the living benefits market in the US and reported: “There would appear to be considerable barriers to entry. That is because the concept demands cutting-edge intellectual capital as well as highly sophisticated management practices and controls supported by powerful computer technology.”

In the US, living benefits products have grown to become a $130bn a year unit-linked market and less than 5 per cent of consumers buy an annuity. In the UK, over 90 per cent of retirees choose to buy an annuity.

These third way products, as they have been collectively termed, are here to stay in the UK. To quote Cazalet Consulting: “The product opportunity for living benefits in the UK would appear to be immense.”

Cazalet predicts that living benefits have the potential to become a £20bn a year market for single-premium pension accumulation sector and a £1.5bn a year market in the income drawdown arena.

But what will it mean for financial advice? A simple way to understand the impact of these new third way products is to divide the way we view consumers’ needs for pensions into three distinct needs – accumulating assets, consolidating assets and de-accumulating assets.

First, accumulation. The main objective here remains constant, that is, to save and grow a pension fund capable of maintaining a good standard of living in retirement and avoid outliving that pension fund. Providing a guarantee at this stage means that the pension fund is protected at all times. This becomes more and more important as the client nears retirement.

Then there is consolidation. When nearing retirement, clients will often consider two main concerns. First, they look at consolidating the various pension plans they have accumulated to enable holistic advice through asset allocation, improved information and investment choice. Second, and most importantly here, the process begins of moving a fund away from volatile assets such as equities and towards bonds and cash, that is, lifestyling.

By guaranteeing a pension fund, this advice process is challenged. Investors can remain invested in equities, and the growth opportunities these provide without fear that their pension would suffer as a result of sustained falls in financial markets. Advice can instead remain focused upon how to best grow the fund ahead of drawing income.

Lastly, there is de-accumulation. Previously, the advice crossroads that advisers and their clients found themselves at was one of a choice between annuities or income drawdown. Today, however, a third way is being offered.

As discussed, people desire greater flexibility in their retirement and pension products must afford them this if they are to remain valid. Annuities are clearly not flexible and in most cases the level of income is static or grows at a predetermined rate. Plus, once the annuity is purchased, the role for advice ceases.

Drawdown plans do require an ongoing advice process. However, for the large majority of individuals, a drawdown plan is not an option as it does not provide the security and certainty of a guaranteed income. Quite simply, they cannot risk their fund.

By providing the certainty of guaranteed income while remaining invested in assets that can deliver growth, advisers have a continued role. A number of the third way plans lock in a proportion of fund growth annually. This necessitates communication with the client, who may want to switch funds, annuitise part of the fund, increase or decrease the amount they withdraw from the plan and so on. Ongoing financial advice remains an important element.

Third way products offer customers a greater level of choice and flexibility when planning income in retirement. In turn, however, this has presented advisers with a significant opportunity and is opening up a new grey market.

Demographically, this market is growing. As the population ages, this new opportunity will get bigger every year. Catering for this grey market and servicing their needs is becoming a science. This has not escaped the companies providing these third way products and as an opportunity, it should not escape IFAs.

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