Annuity Panel (October 2007) - What next?

CHAIRMAN: Billy Burrows, director, William Burrows Annuities
Burrows first became involved with annuities nearly 10 years ago when he helped to establish Annuity Direct. William Burrows Annuities was created in 1998 and one year later Burrows was asked to join Prudential Annuities as business development director. In 2001, Burrows re-established William Burrows Annuities.

Mike Douglas, managing director annuities, Aegon Scottish Equitable
Douglas Aegon Scottish Equitable in August 2006 from Partnership Assurance where he was chief operating officer. He has extensive experience within the financial services market and his knowledge of the annuities market is considerable.
Aston Goodey, head of sales (retirement solutions), Prudential
Goodey has been with Prudential for 20 years. He has held a variety of managerial roles in finance, commissions and life and pensions. Goodey has completed a diploma in insurance and financial planning.

David Greenall, distribution development manager, Canada Life
Canada Life has built a strong position in the open market option market with a reputation for highly competitive pricing and excellent levels of service. Playing a key role with this continued growth has been business development manager Greenall.

Matt Trott, product and marketing manager, Tomorrow
Trott joined GE Life, recently rebranded as Tomorrow, in 1992. He has worked in all parts of the business, including the sales office, operations and managing the pensions technical team. He is now responsible for developing Tomorrow’s annuity products.

Neil McCarthy, head of sales, Partnership Assurance
McCarthy has been involved in life assurance since leaving university in 1983. Primarily involved in sales and marketing, he spent seven years as head of personal finance sales at Swiss Life, having launched the Solution range of protection products. He is responsible for managing the distribution team at PA in the UK.


Burrows: It seems many company defined contribution schemes are not offering the option market option to their clients. What should the industry do about this?
Douglas: It is important to have consistency and fairness across all pension products and all companies in the industry. As the average pension fund at retirement is around £25,000 then most people need to maximise their income and the best way to do this is through the open market option (OMO).
Any scheme not wanting to offer the OMO to its members would have to satisfy themselves that their approach met the Financial Services Authority’s Treating Customers Fairly principles.

Goodey: I do not believe this is the case now in the UK. Five years ago (in 2002) the FSA changed the rules so OMOs had to be offered/informed to members of the vast majority of DC schemes. This means that the option does exist, the key question is how well is it communicated and how easy is it for a member to exercise the right to an OMO. This was a topic picked up in the recent pre-Budget report and has again been subject to recent FSA scrutiny. At Prudential we make it clear to members the option of OMO. We think it is important for customers to be given the choice.

Greenall: Fundamentally, DC schemes should be no different to individual schemes where there is an agreement that the OMO should be highlighted and explained in the options at retirement communications. If there are reasons due to the nature of the scheme why this would disadvantage members, they need to be explained but in principle members should not be prevented from exercising OMOs.
Scheme advisers should look to ascertain why this is not an option. Is it a lack of awareness? Not understanding the potential benefits OMOs have for members, not having a process/structure to cater for these or is it a fundamental issue with the scheme, its mechanics and pricing? The scheme advisers should be encouraged to discuss these questions with the trustees and ascertain why OMOs are not offered.

Trott: All DC customers have a legal right to purchase an annuity on the open market, and all schemes are obliged to inform members of this right. For those schemes that flout this law, The Pensions Regulator should take the strongest possible action to correct the position.
Having said this, I believe that the majority of schemes are fulfilling their legal obligation to inform members of their rights to an OMO. However, I also believe that this message is still not being fully understood by many DC scheme members, many of whom are unaware of the difference it would make.

McCarthy: Most people only get one chance to maximise their income at the point of retirement, so it is crucial all DC scheme members are given the chance to review all the options available.
Our research shows that retirees miss out on £1.25bn of pension benefits every year through lack of awareness of the OMO and by not shopping around. This is supported by research (2005) by the Association of British Insurers which shows that only 52pc of retirees have exercised the OMO.
An example of where people are missing out is shown by our research: we found that half of people over 50 who suffer poor health are not aware that their medical condition could make them eligible for an enhanced annuity rate through Partnership.
One way to address this is obvious: give members an information pack ahead of their chosen retirement date which is clearly written and explains – most importantly – that they can shop around and that specialist qualified advice is readily available. This gives people the chance to discuss their retirement planning with professional advisers and put themselves in the best possible position as they approach retirement.


Burrows: The majority of annuities purchased are level annuities. Do you think this is storing up trouble for the future if inflation rates increase?
Douglas: This could potentially be a problem. However the yield curve has been inverted for several years – meaning the long-term outlook is for interest rates to be lower in the future than they are now.
If the market is right this would suggest that the risk is low. It does also, however, increase the customer perception that annuities are currently poor value. And this outlook may not be borne out in reality.
But, income needs in retirement aren’t level. When people are active in retirement they need more income and as they reach a more passive stage they need less. As there are very few annuities (or other retirement products) which match this income shape then it’s perhaps understandable that people buy level annuities. At least in this way they can manage the fluctuations themselves – banking excess income when they don’t need it, to build up a nest egg to use later.

Goodey: There is a big education piece required with consumers that ensures they understand the financial risks of living longer. Once people start to recognise the length of time they are now in retirement we can then apply some simple math to the equation.
If you are now typically in retirement for 25 years and inflation runs at about 2.25pc then your purchasing power will have almost halved over that period. If inflation were to go to 4pc (which is far from inconceivable) it would only take 15 years for your purchasing power to have halved. This is where it is key we educate consumers on the alternative annuity options.
The most obvious choice being an annuity linked to an index – in particular the retail price index. The problem with this is the income starts about a third lower than a conventional annuity and while over time it may prove the better option most customers need to maximise their starting income. An alternative is an asset-backed annuity and in particular the With-profits annuity.

Greenall: Potentially. It is difficult to make a general statement. With advised cases you would expect the decision to be based on an assessment of the client’s circumstances and the client making an informed choice. This may be less likely if the client deals directly and may have a lack of understanding of the consequences of their choice(s). Increasing inflation will have an impact regardless of the basis of decision, the key point is how much of a factor was inflation in making that choice.

Trott: There are many legitimate reasons why a customer would buy a level annuity. Indeed, it could be argued that the lower relative return available on inflation linked annuities means that customers would generally be better off buying a level annuity.
My concern is therefore not around the number of people purchasing a level annuity, but the thought process behind this decision. If professional financial advice has been given, and future risks of inflation considered and mitigated, then the purchase of a level annuity may well be the appropriate course of action.

McCarthy: Linking retirement income to inflation is a “no-brainer” – of course a customer would do it – until they discover that the cost of an retail prices index (RPI) annuity is such that it would take years to reach the initial income of a level annuity.
For example, we calculate that for a male aged 65 with £100,000 to spend, an annuity with no escalation would give them an annual benefit of £7276.23 compared to £5073.65 with an RPI annuity. Even with relatively high inflation, making up the difference would take many years, and in those early years the individual is living on reduced income.
By definition, however, not linking income to inflation is storing up problems for the future as people’s incomes will devalue over time. One solution to this problem is for people to save more for retirement – allowing a reasonable level of escalation. Other solutions to this may include phased retirement; for example, continuing to work on a part time basis or in a different role beyond your retirement date, utilising other assets such as ISAs, which create a different type of retirement income.


Burrows: Do you have any evidence that the increase in drawdown plans is taking more share from annuities and in the future do you think annuities will only be bought by those with modest funds?

Douglas: Clearly an increase in drawdown sales must be taking share from annuities – although this is largely a timing issue as much of the fund will ultimately come back to an annuity. It’s difficult to be sure whether this is a long-term trend though as opposed to a short-term swing. It tends to be the case that there’s a swing to drawdown when investment markets are buoyant but this tends to swing back when stockmarkets are more volatile or after a crash.
We do not believe that annuities will only be bought by those with modest funds in the future as our research shows the majority of people want the guarantees that annuities bring.

Goodey: It is difficult to evidence this but with drawdown now being written at lower premiums it is not unlikely that some of this would have traditionally gone into annuities. I also think the ability to take tax-free cash (TFC) and no income has been a massive appeal to consumers.
Rather than wait to buy an annuity when they need the income many will be releasing the TFC now through a drawdown plan, only then to annuitise when they need the income. Ultimately, for the vast majority of people an annuity will continue to be the secure option to providing an income for life whether purchased at 75 or before.

Greenall: We need to be careful about our terms here, but generally a standard annuity will have less appeal to high net worth clients who may have other investments and savings factored into their retirement income planning. They are therefore looking for drawdown/third way type products to give them flexibility.

Trott: Drawdown now represents just over 20pc of the pension decumulation market, which is up from around 15pc two years ago. However, recent tax changes have reduced the relative attractiveness of alternatively secured pensions, and, in the absence of any other alternative I suggest that the vast majority of people will continue to look to annuitise by age 75 at the latest.
With the recent increases in life expectancy, many commentators are now questioning the appropriateness investing in such a rigid fixed-interest investment vehicle for the whole of an individual’s retirement. However, I strongly believe that annuities will continue to match the customer needs of those unwilling to accept the investment and/or longevity risk associated with its alternatives. These people are likely to include not just those with modest pension/retirement assets, but those with medical impairments and those of an advancing age, which, let’s face it affects us all sooner or later!

McCarthy: The inherent strength and most compelling aspect of an annuity is that it guarantees an income for life – i.e. it provides certainty in a very uncertain world – whereas drawdown plans may have some volatility. Drawdown plans are increasing, but instead of eroding annuity market share across the board, we are finding it is mostly people with larger funds that are choosing them.
And even then, some people are choosing to have some of the pension fund as an annuity and put the rest into drawdown plans. Therefore we anticipate that the core market for drawdown funds will continue to be people with larger funds who want, and understand, the risks associated with these products, and that the annuity market will remain strong.


Burrows: What do you see as the important trends in distribution? For instance, do you think direct offerings from product providers will increase for smaller funds.

Douglas: We see one of the key trends being the ability to open up advice to all – particularly the mass market. The FSA’s retail distribution review (RDR) and the Thoresen Review are currently looking into these. The sad fact is the customers who most need advice to maximise their income and improve their financial situation in retirement don’t have access to it.
Of course, providers have a part to play in this too, as it can be hard to offer full advice on smaller funds within the (traditionally low) commission on annuities. So, the focus then shifts directly onto the process.
If we can also speed up transfer payments so customers start receiving their income soon after completing the application then we really would have a slick process.

Goodey: I believe the landscape will change as a result of continued market pressures and the impact of the RDR. As we are seeing now, many advisers will increasingly seek out more flexible retirement income options for clients with larger funds and more varied income needs.
However, for people with more modest funds and a guaranteed income requirement, it is at present often a challenge for an adviser to be able to offer full financial advice on a commercial basis. This is where the RDR might assist in the future. Through the proposals around the new “primary advice” category, it could become more cost effective to offer conventional annuity advice, meaning that smaller case sizes could still be handled by advisers.
Equally, there may be an even greater role to play for providers and others through offering annuity advice direct to customers,.

Greenall: I believe this is a possibility if clients become more aware of the options and annuities as a whole and advisers concentrate on more lucrative business.
If we follow through and anticipate that clients do become aware of and exercise the OMO, then for smaller funds they may wish to, or be encouraged by advisers, to deal direct with providers purely because there is little value to either party in taking advice.
I do not expect minimum premium levels set by providers to fall or for providers to necessarily be actively looking for direct business, but simply a greater awareness by clients and limited return for advisers will combine to create this outcome.

Trott: I believe that generic advice could have the biggest impact on the distribution of financial services for decades. Although everyone could benefit from professional financial advice in the run up to retirement, the industry has struggled to deliver this in a cost effective manner for those with small funds and on a modest income.
Depending on the framework that is delivered, the generic advice model could fall short of advising customers which insurance company to purchase an annuity from. In these circumstances, providers may feel more comfortable writing annuity on a direct basis, given that customers will already have received a suitable level of financial advice to ensure the annuity they are buying is appropriate for them.

McCarthy: There is a need for the number of advisers giving specialist annuity advice to continue to grow, especially as the OMO becomes more established by consumers. The challenge they face is being able to give high quality advice.
There are however a growing number of specialist annuity desks providing a great service to customers who want to shop around. Specialisation naturally helps to bring about business processing efficiencies. The industry should also look to reduce complexity for advisers and consumers.
Simplified documentation and stronger ‘encouragement’ from the FSA for ceding schemes to transfer money to annuity providers are areas that are being looked at at the moment.
While I am sure product providers will look towards direct offerings, they will not specifically be looking for small funds. As circumstances and medical history have such a bearing on the level of income and the type of annuity chosen/available, a customer should go to an adviser offering a broad selection .
The whole “at and in retirement” market is set to boom so simplifying and demystifying the process for customers will improve distribution opportunities for all of us.