What is the pensions equivalent of having your cake and eating it too? Many see it as getting investment growth in drawdown while also having the guarantee of secure income.
Yet when advisers sit at the table with clients this option is rarely on the menu. Two possible starters that could potentially satisfy client appetites are guaranteed drawdown or deferred annuities.
There are stark differences between the two options: deferred annuities start at a known date in the future and the income is fixed, level or escalating, while guaranteed drawdown is an option turned on at any time for a cost. Here, the income is determined by fund value and how much you want to draw down.
However, there is an immediate problem with these two options: they are seen as expensive, in short supply and anything involving annuities seems out of date to advisers.
Technology & Technical managing director Kim North laments both the lack of hybrid products available and knowledge advisers have of them.
She says: “In the mid-1980s every annuity provider had a deferred annuity option and these were useful for people who did not have a lot of defined benefit cover but needed some guarantee of income. You can get deferred annuities in the US but a lot of advisers do not know about them here.
“I do not know why providers are not trying to do more as there is a gap between annuities and drawdown that needs to be filled.”
Calls for product innovation
Research backs up this view and suggests there is a spot in the market that needs to be filled sooner rather than later. Earlier this month, Aon published a paper on the challenges of decumulation that shows a combination of drawdown and repeated annuity purchase solutions are being pioneered in the US.
It says this type of product was developed and launched to the UK retail adviser market between 2007 and 2009 but failed to catch on. One example is Canada Life, which created a temporary five-year annuity that did not take off. The paper asks if it is time to make these products a reality in the UK again.
Aon senior partner Kevin Wesbroom says the need to create hybrid products, such as deferred annuities, is more pressing now than it was a decade ago.
He says extending the role of advisers from talking about investments to whole-of-life solutions is important and the pension freedoms offer an opportunity to be innovative.
Unfortunately, the track record of advisers getting on board with either guaranteed drawdown or deferred annuities is not good.
Furthermore, life insurers have been pulling these products as advisers have not been taking them up. MetLife, which sold guaranteed drawdown to around 50,000 customers, withdrew from the market in summer last year.
Aegon followed in March and closed down its guaranteed drawdown business due to insufficient demand.
Aegon pensions director Steven Cameron says the product was removed because it was not getting traction with advisers and thinks a possible explanation is compliance departments at advice firms viewing it as a niche product.
He says this part of the market is most rife for innovation and needs to be driven by customer demand and embraced by advisers.
So, where can the UK gain inspiration? One possible example comes from the US, where the University of California is working with State Street Global Advisors to create a deferred annuity solution for employees.
It expands the default component of a target date fund to include longevity insurance in the form of a deferred annuity. This is achieved by using a portion of the accumulated target date assets at age 65 to purchase a deferred annuity (known as a qualified longevity annuity contract) that will start payments at age 80.
State Street senior managing director Nigel Aston says: “It is a complex process and a sophisticated solution that involves a lot of collaboration and innovation to get right. We intend to fully realise this for the members of the plan over the next year or so.”
Advice is key
Better Retirement director Billy Burrows is sceptical about the need for more product innovation and says better advice rather than new products is what is required.
He says for a lot of people the solution might be to start in drawdown and buy an annuity later with the caveat being it depends on circumstances of the time.
Quilter retirement policy head Jon Greer believes how clients react to market conditions will ultimately decide whether these products are able to take off.
He says: “It may be that advisers will become more interested in these products if we see continued market volatility.
“But a lot of the decision will come down to how the client feels about the amount of risk that they are wanting to take and whether they are happy to be riding the ups and downs of the market.
“The relative outcome of different options will depend upon future market conditions.”