Ask the Experts: Unit-linked guarantees - cost & complexity

Question: Complexity and cost are two reasons I give when asked why I don’t recommend unit-linked guarantees to my customers. Are we likely to see more cost effective products coming onto the market?

Answer: Colin Bell, European variable annuity product director, Aegon

The issue of complexity comes up a lot with unit-linked guarantees, but in my view it's more perception than reality. I would contend that the customer proposition is quite simple.

For a regular guarantee charge, these products allow you to invest in a mix of equities and bonds with greater security than before while retaining flexibility - whether that be through a capital guarantee on defined dates or through limited term or lifetime withdrawals at a certain rate.

They can insure you against financial dangers - which could seriously affect your future income in retirement - while still giving you the potential to benefit from good market performance.

The guarantees rest of course on the claims-paying ability of the insurance company and perhaps this is where the complexity comes in. Advisers will want to be as sure as they can that the provider will be around to honour any guarantee.

Therefore, they need to understand a bit more about how the insurer is managing its risks. Providers supply information and materials that help advisers in this respect and make this as simple to understand as possible.

Turning to cost, you would expect to pay something for a valuable benefit. Repeated market gyrations in the last few years have demonstrated that protecting your income and standard of living in retirement is not a theoretical exercise.

So what then is a reasonable cost for these guarantees? Guarantee costs are directly linked to the market costs of the types of financial instruments that insurers use in their risk management processes for these products.

These in turn vary mainly with the level of longish term equity volatility and longish term interest rates. So, when market conditions are stable and long term interest rates are not unusually low, the cost of future guarantees will be lower than when equity markets are unstable or long-term interest rates are unusually depressed.

That is, when conditions are volatile and there's a raised chance of the future guarantee biting, the cost will be higher and vice-versa.

Research carried out by AEGON in Sept 2009 showed that the top 3 retirement scenarios that most concern the pre-retired were "running out of money" (30%); "having to rely on the State to look after me in old age" (17%) and "my income reducing in retirement" (14%).

Of the sample of 1419 people, 52.5% were prepared to insure their retirement income and many considered the current pricing of these types of products to be reasonable.

It's a competitive market place and there is no sign that typical charges being set by existing players are unreasonably high for the guarantees offered. So I don't expect significantly lower charges for this quality of guarantee.

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