Mention the word annuity and even your most enthusiastic pension adviser will probably want to go away and do something less boring instead.
But that may be set to change following the publication of a Treasury paper on the annuity market.
The paper, called The Annuity Market, appeared alongside the pre-Budget report last month and is being hailed as a breakthrough which could help to revolutionise the retirement income market. The Treasury is inviting industry ideas on how to move annuities forward.
Until the introduction of drawdown in 1995, annuities, and the accompanying 25 per cent tax-free cash, were the main way, if not the only way, of taking pension income.
High interest rates in the 1980s and early 1990s meant that, on the whole, annuities allowed investors to buy into a fairly decent retirement income.
But all that has changed as lower interest rates, combined with lower bond yields, have seen annuity yields fall.
The need for a product that allows investors more flexibility – the ability to invest in a wider range of assets for example – has long been on the pension industry wish-list.
Annuity Direct director Stuart Bayliss says the publication of the paper shows that the Treasury has at last realised that it needs to work with the industry to look at ways of revitalising annuities.
He says: “The paper is telling the industry that if it comes up with more ingenious ways of structuring annuities, it will look at them.”
The paper does not, however, suggest a radical overhaul of how annuities will work. There is no suggestion that the two fundamental elements of an annuity should change and the definition of an annuity will remain as a product that should provide a regular income and that the underlying investment should be a pooled risk product.
Aegon head of annuities marketing Ian Kerr has already presented the company’s own views to the Treasury and says one of the company’s suggestions is the development of a U-shaped annuity.
Kerr says that this will be a lifestyling product which would pay out more at the beginning of its life to take account of immediate pre-retirement needs. He says those in the early stages of retirement often have larger expenses, such as paying off a mortgage.
“Then the payments would dip as people’s expenses go down, increasing again to take account of potential expenses such as long-term care needs.”
The Treasury is also being advised to remove the compulsory annuity purchase at age 75 requirement – but as a publica relations exercise more than anything else.
Kerr claims: “It affects very few people but creates enormous ill will.”
He believes that the thinking behind compulsion is misguided. “The Government is concerned that a lot of people will rely on the state but most people are still buying their annuity at 65 and not waiting.”
Origin head of annuities Nick Flynn predicts that the paper will give guaranteed drawdown annuities a fillip.
This form of annuity allows investors to guarantee their income up to age 75 but, because they are investment products, the retiree can benefit if their investment does well.
If they die, their family will inherit the amount of the fund as a cash, thereby removing the need to buy a joint annuity, although the cash will be taxed at 35 per cent and the annuity can cost up to 5 per cent more.
But new products are not the whole story, claims Bayliss. He says increasing awareness of the open market option, which allows people to shop around for an annuity, is all that is really needed.
He points to the poor take-up of complex investment-related products such as those being sold by Prudential and Canada Life. These products remain invested up to age 85 but have brought little interest among investors.
He says: “Too much complexity is a bad thing. There is nothing wrong with annuities, just how they are marketed. You make choosing an option part of the process.
“If people shop around and get a better-priced annuity, they get more income, the Government gets more and more tax and the reliance on pension credit diminishes.
“There will be some fancy products as the industry get used to how people are going to be pacing work in the future but the real issue has to be in getting people to know their options.”
Kerr agrees that usage of the open market option remains an issue as only half of investors use the option.
He says: “There is low awareness at the bottom end, where people are financially very unsophisticated. They have no idea that they have an option and think they have to stick with what they have got.
“There is very little margin for advisers. Commission is only 1 per cent and it is a lot of work for a very complex sale.
“We have to educate people about annuities. The widespread view of annuities is that they do not offer real value for money and if people die early the money goes back to the big bad insurer. People do not know that, in fact, the money goes straight back into the annuity pool for other investors to benefit.
“Our job as an industry sis to spread the word that annuities are not as bad as people think they are.”