A more enhanced option

Helen Morrissey talks to a panel of industry experts about what the future holds for the annuity market.

Helen Morrissey: Many people criticise annuities for being outdated and inflexible but recent innovations show there is still plenty of life left in them. Are you seeing any changes to how people are utilising annuities as part of their retirement planning?

Billy Burrows: Yes. People are increasingly becoming involved in their retirement decisions and using combinations of annuities. Conventional annuities remain most popular but people are increasingly getting the message that if they are investing for a long time then it is beneficial to have at least some of their assets invested in real assets. As a result we are seeing an increase in the use of with-profit annuities, flexible annuities and even drawdown.

Robert Tinsley: Yes, I think that is accurate. The only thing that is different in my experience is that I have not seen any increase in new drawdown activity. However, we without doubt, are seeing increasing interest in different retirement options.

Morrissey: Why do you think people are keeping away from drawdown?

Tinsley: We are not seeing many new people going into drawdown and this is very much down to people’s attitude to risk in the current environment. However, we are not seeing drawdown customers moving into annuities either. A lot of clients are deferring decisions, hoping markets will improve and their fund values will recover.

Vince Smith-Hughes: Investment linked annuities are becoming popular as people coming up to retirement realise they have lost some of their retirement pot. They do not want to crystallise that loss and so do not go into a conventional annuity. They want to remain invested in some form. There are contracts now that provide flexibility when it comes to taking income so maybe we will see these playing an increasing part in peoples’ decisions going forward.

Aston Goodey: One thing third way annuities did was make people realise there were other options out there. Whether they use these options is another matter but at least they are exploring them. Another thing on the incline is the impaired market which I think will continue to grow. We need to continue to help educate to ensure people buy the product that best meets their needs as well as looking to provide increased choice.

Morrissey: How have you seen people’s level of understanding of their options grow over the last two years?

Simon O’Connor: There are an awful lot more options out there. Consumers may not necessarily know that, but I think the IFAs do. We are also seeing people increasingly go to their advisers rather than simply taking the annuity they are offered from their pension provider. From our perspective the movements in the investment markets over the past year or so have done much to bring things like third way annuities into the spotlight. Another area where we have seen growth is in drawdown to drawdown transfers. I think there is plenty of room for all the options and the more choice people have, the better. Even if people end up with a conventional annuity at least we know people have made an informed decision.

Morrissey: Are you seeing that people are engaging more with their retirement decisions?

Tuhin Ahmed: I think they are definitely engaging more in the open market option (OMO). They realise they may not necessarily get the best rate from their pension provider and so they need to get some professional advice on what is available. The majority still go for conventional annuities but that tends to be based around purchase fund size. We are seeing a steady rise in the number of income drawdown cases, though, especially at the higher end of the market

Morrissey: What we have also seen is a growth in the impaired market over the past year. Aston, how do you see the market moving forward from here?

Goodey: I think the enhanced market has effectively moved the conventional market to the next level. What it has failed to deliver though is flexibility. It is a rate driven market and most of the providers will offer a fairly bog standard rate and you cannot take those impaired terms into other products. I think we need to innovate more. We are coming into this market space soon with a product that offers flexibility of choice, investments and income with an element of guarantee for both conventional and impaired terms. This, along with the Pru will be the only products in this space and I think this is a space that will continue to grow. 

Morrissey: Impaired annuities have grown but how much further can they grow?

Goodey: There are various stats that say 40% of the market could get impaired terms. However, I know there are firms out there writing 50%+ of their business on impaired terms. This is down to the way they conduct business and get the right information out of people. We just need to continue to educate and ensure people know the opportunities that exist in this market. It is also overcoming traditional hang-ups that people do not want to disclose the full extent of their health conditions. They need to realise that it can benefit them and get them a higher income.

Burrows: I am always a bit concerned when we take a broad brush approach to the retirement market as we need to understand the different segments. Most people with medium to large funds are using the open market option; it is those with the smaller funds who are not benefiting due to the cost of advice. It is wrong to assume the market is not working. The thing with enhanced is you have to wonder about how long it will be until everyone at retirement is filling out a medical questionnaire for an enhanced rate?

Morrissey: What can we do to ensure people with small pots are getting the best annuity for their needs?

O’Connor: It is a difficult one to crack and the best thing we can do is continue to promote the fact that people do have choices. Going forward, I think we will see a greater use of things like websites. People are used to using them for car insurance and things like that – maybe we could see this happening in the annuity market.

Morrissey: Would you agree with that Vince?

Smith-Hughes: I would say one thing that would really help is if people knew where to go to get information. At the moment we have some good information coming out of the DWP, HMRC, TPAS and the FSA but people don’t know where to go to get it. We need to put it in a centralised place so people know where to access it because at the moment it is all over the place.

Morrissey: I think we have discussed this before. This is where a service like Money Guidance could come in and provide a central place people can go to get information. Would this idea have legs in it Robert?

Tinsley: I think the more we can do to provide people with information and direct them towards OMO the better. It is also about making sure people understand the benefit of seeking advice and the difference this can make to their long-term income. Without this information and access to guidance they simply will not seek out the impaired and enhanced products.

Ahmed: Is there nothing providers can do to reduce the charges of these products to make them more viable for those with lower pension funds? 

Burrows: Annuity pricing is very complex and if you speak to a pricing actuary they would argue it is very difficult to reduce the cost of an annuity. Indeed with increasing longevity and adviser fees they would argue that the costs need to increase.

Smith-Hughes: We looked at variable annuity products over the past year and the price of offering attractive guarantees would have made it too expensive.

Morrissey: Do you get the sense that now is not the right time to launch a third way annuity?

Smith-Hughes: That is certainly the decision we came to which is why we launched Income Choice as an alternative. This contract provides the potential for growth in income along with an underlying guarantee, so it may appeal to many of the same people.

Tinsley: The difficulty is that we are at a point where the product would be popular but the pricing is making it unattractive. We need the market to develop a bit more but I do genuinely believe that the concept will take off. 

O’Connor: I would think that if we did not already have a product in the market now would not be a good time to launch one. I think having had a product in the market for two years we can see there is a real need for it. It is important that this product is in the market and we have to ensure we continue to price it effectively as the price of guarantees is going up. 

Goodey: What proportion of the products you sell is sold with guarantees? 

O’Connor: Probably about a quarter with the guarantee in place. People buy it because there is the option to turn the guarantee on. At the moment people feel that the market is about as low as it is going to get, so why do I need a guarantee now? I will buy the product now and then when the market has recovered I will turn on the guarantee and lock my gains in place. I think this is a real factor that has drawn people to the Lincoln product in particular as they do have this flexibility.

Burrows: We must not underestimate what a strong customer proposition this is. I keep saying that if you were to ask Middle Britain what they thought of annuities they would not be impressed. If you asked them about income drawdown they would say they like the flexibility but that it was too risky. As a result a product that offers people an annuity type income with drawdown flexibility does resonate with people. The problems are around the pricing of the guarantee. The UK financial services landscape is also very different to that in the US and Japan in that we operate in an advised world where the adviser needs to be able to compare products rather than selling a particular product.

Morrissey: Can you see further segmentation in the retirement market then?

Smith-Hughes: There is certainly scope for asset backed annuities to grow. As a market segment, it has been underused in the past. It can be very attractive. We still see a huge proportion of people coming to the market buying conventional annuities, often with no spouse’s pension or indexation – this could be the right option for some people but certainly not all of them. I think the asset backed annuities market has real potential to meet the needs of a lot of these people.

Goodey: The area I think will grow will be more on the annuity side. The third way concept has been aimed at high net worth clients whereas the rump of the volume is in the mass market. The point is, it is those people who have not been given a choice. Most commentators think annuity rates will continue to go down and people need options to get the most from their retirement income. We need something that is simple to understand and inexpensive. Once someone has cracked that market place we will see others dive in.

Burrows: There are lessons to be learned from the investment world where people put together investment portfolios. We need to help people understand they can have a retirement investment portfolio where the lion’s share is guaranteed. Rather than being product focused, people should have a holistic retirement portfolio.

Tinsley: That is absolutely right. We will see real change in the structure of people’s retirement income. It will be solutions led with many people having more than one product delivering their income. However, this does not address the issue for those with smaller pots. That is were innovation is needed in the £30-£100,000 range. We need increased flexibility as well as security there.

Burrows: A good way of opening up the market is to talk about the issue of shared risk. If you look at people’s objectives, they want a secure income over their lifetime with the chance of growth to offset the risk of inflation. You can go back to the individual and say one way to get your pension to work harder is to share some risk with the provider. However, do investors trust insurers enough to share risk with them?

Smith-Hughes: That is a good point Billy. The other thing is, if you have a small fund then you have to take some risk at retirement. This could be the investment risk of an asset backed annuity or drawdown, or it could be risk of living too long and seeing your annuity income being eroded by inflation over time. You have to take on some kind of risk, it is just working out what kind of risk it is going to be. 

Morrissey: Are we seeing a growing awareness of the impact of inflation?

Ahmed: I think people are talking about it and wondering how it will affect them. They are looking at RPI and LPI linked annuities to see if they are the best options. We are also seeing discussions around with-profits as many clients find the price of inflation linked annuities too high.

Morrissey: Also people have to sacrifice income in the early stages which puts them off inflation linked annuities. Is this a factor?

Ahmed: That is one of the biggest stumbling blocks.

Smith-Hughes: It is now more popular to use a number of different products to try and mitigate the effect of inflation. So we could see a level guarantee annuity being used along with an asset backed annuity to give potential income growth alongside a decent starting income.

Burrows: For a lot of pensioners their levels of inflation are much different from working people’s. Inflation also is not uniform. People can cope with gradual increases but they cannot cope with a spike – how do they protect against that – do they use real assets?

Goodey: The inflation piece has always been a big issue. In fact we put out a press release today analysing how much it costs people in different age brackets. Compared to a person in their 40s it is a definite fact that as you get older your spending is increasingly biased towards things like utilities – they have gone up more in price than for example, plasma TVs. Pensioners are being penalised and advisers need to be very careful when recommending level conventional annuities. Inflation needs to be part and parcel of the discussion. 

Burrows: The Pension Policy Institute did some research and some of the results were counter intuitive. They looked at the value of pensions for those at the smaller end of the market. The smaller your personal pension, the greater the impact of the state pension. So, if the state pension is increasing, a lot of people may find a level annuity will better suit their circumstances. It is probably a more sophisticated issue than we first think. 

Morrissey: Legal & General recently announced they would sell enhanced annuities direct to customers on the proviso they would like people to seek independent financial advice before approaching them. How do you feel about enhanced annuities being sold direct to clients?

Burrows: Clearly there is a gap in the market for those who do not have access to the traditional adviser market due to fees. Provided the insurance companies can prove they are adding value then I have no problem with this approach. The issue I would have concerns with, is where people may be filtered down a particular route without realising they have other options.

Smith-Hughes: Yes I agree. If it is absolutely clear to people they are able to shop around and there is provision of information around other retirement contracts available then it is great they have this extra choice.

Ahmed: As long as they make it clear it is information rather than advice then I have no problem with it.

Morrissey: If we move on to the issue of annuity transfer times. It has been a problem for some time now, but the ABI Options campaign does seem to be making some inroads into this. Are we seeing light at the end of the tunnel?

Smith-Hughes: I think there is some light at the end of the tunnel. I think it is working well with those who have signed up to it and it has significantly improved transfer times. Two big improvements I would like to see happen is to bring in those providers who still drag their heels. Quite often they are the ones who are not active in the market and they may well need the FSA to drag them into it. Another thing I would like to see is it extended out to other types of transfers such as to drawdown. I can not see any reason why this could not be achieved and I think this would be a huge step forward.

Morrissey: Why are people getting on board now? There have been so many initiatives over the years that have not taken off – so why now?

Burrows: There have been key individuals in the market who have really pushed it and ensured people have got on board. I think also a lot of people have underestimated the impact it could have. One impact is that people will be able to vest their pensions without having to wait two or three weeks for a retirement pack. If you look at the annuity purchase process the actual setting up of the annuity is quite straightforward, it is getting all the transfers that is the tricky bit. If we can eliminate a lot of the bureaucracy then we can see real improvements in the process.

Goodey: You do need a core group who come up with a process and get others involved. After a while you feel left out if you are not a part of it. I do not think it is good to not be a part of this campaign. We need to be doing something similar around the OMO.

Morrissey: It tends to be the same people who sign up to these initiatives and often the same people who do not. Are you seeing those who would not sign up in the past looking to get involved now?

Smith-Hughes: There is more pressure for people to get involved.

Tinsley: I think it is a very positive thing. The only problem is the stragglers – those who tend not to transact business in the ‘at retirement’ market but still have big pension books. They are not looking to get involved in the initiative and we may well need some teeth from the FSA to get them on board.

Burrows: I think you will find that may happen. These companies will need to have a great excuse to not take part.

Morrissey: Do you think we should name and shame providers who are not up to scratch?

Goodey: Some of these providers have been named and shamed for years but it makes no difference. I think you have to compel them. Those people who want to do business need to be involved in this initiative. Those with closed books of business do not want to take on the cost of getting involved.

Ahmed: Transfer times can be a real issue and some companies are better than others. I had a situation where one company would not sign the other company’s form while the other would not accept the letter from the other to say they were a life company. It took a while to sort out and during this time the pensioner was not getting their income. It is not always this bad but you do get problems.

Burrows: One of the good things about Options is that we have standardisation of forms so these things should not occur. I always found it ridiculous that a ceding scheme needs a letter from Prudential to say they are an insurance company.

Morrissey: What more can the industry do to enhance awareness of the OMO.

O’Connor: It is difficult to see how we can do this. Until you make OMO compulsory then it is always going to be difficult to give it the prominence that it needs. People need to actively do something about it. In many ways the process has gone as far as it can, and until we can do something that forces someone to actively go and look at other options then we can not move forward. Often the pension pot is the second biggest asset a person has after their home and they need to make it go as far as they can.

Morrissey: Providers were asked to improve the quality of the literature they send out on the OMO – are you seeing any change?

Tinsley: I cannot say I have seen any real difference. Providers mention the OMO but still tend to focus on promoting their figures and most retirees will simply tick the box with the largest number. The only way around this would be to make the OMO the default. We are seeing more pension scheme trustees taking an interest in access to advice but it is more difficult with the DC market and GPPs.

Burrows: If you think about pensions for a lot of people they just pay their money in and the rest of it is done for them. Then at retirement they are faced with a big decision. We need to get people engaged much earlier. 

Tinsley: All the effort on communication tends to go into the accumulation phase but what happens to people at retirement. We need to communicate with people in advance of their retirement, get them thinking about the coming change in lifestyle and income needs. People need to plan better, make the right choices on shape, structure and protection. A lot more information needs to be produced. Employers can help a lot here.

Burrows: If you look at it from a policy point of view you would argue that maybe some of these schemes should reserve some money to provide advice at retirement.

Smith-Hughes: That is a good point. It is also important to remember it is about more than the best annuity rate. There are a lot of things to think about – do they qualify for an enhancement for instance, what other options are there? Should they be in a third way product? To just talk about the open market option is restrictive.

Burrows: You could get the best annuity rate out there but if your investments have fallen by 40% then that is not great.

Morrissey: What is the best time to contact people in the run up to retirement?

O’Connor: I think that whether it is five or three years out from stated retirement age, the dilemma is how do you get the customer to take any notice of it? More often than not do they read it, understand it or do anything about it? People have to understand this is important. Certainly in this current climate people are looking six months to a year ahead, they are not thinking about their retirement date in five years time. You can bombard people with literature but unless they understand its importance they will not do anything about it. I cannot see how we can get out of this, you cannot force them to do anything and giving them the advice they need could be prohibitively expensive.

Morrissey: Should we see advisers taking a bigger role in the workplace?

Goodey: People tend to look at retirement when they are about five years away, but the problem you have is you have a policy on your books until age 65 – however, they may wish to retire at 61. You need to ask the question – when are you retiring to determine when to provide information. You also need to ask them what income they would like to retire on and let them know how close they are to achieving it.  It should be looked at as a journey.

Smith-Hughes: There is a £150 per annum tax exemption available to be put towards the cost of advice in the workplace. It is not well publicised but it could go some way towards paying the cost of advice. However, though this is a good starting point, the amount does need to be reviewed as it may send a misleading message about the benefit of financial advice.

Morrissey: Are we seeing any movement in the age at which people are looking to retire, bearing in mind people may have seen their retirement pot fall? Are people looking to defer?

Tinsley: There is no doubt this year we have seen a lot of people deferring their retirement. This is fine for those who have that flexibility. However, many are not in that position and need to access their funds immediately. We are also seeing more people continue working, maybe part time with their employer or even in a different role altogether. I suspect that trend will continue. 

Burrows: What I have experienced is people wanting to access their funds earlier. Perhaps they have reached 50 and want their tax free cash to pay things like school fees and debts. It just shows how strapped for cash many people are. 

Morrissey: Are you still seeing a market for scheme pension and ASP?

Burrows: Scheme pension is the buzzword. But once people understand that they cannot pass money down the generations then I struggle to see the advantages of scheme pensions unless the client is in ill health and wants to strip out their income. 

Smith-Hughes: One of the main advantages providers say with scheme pension, is the amount of income that can be taken. However, is it a sustainable income? What happens if you live longer than expected? It is a very technical area and I think it is the right contract only for a small amount of people.

O’Connor: You do not want to increase the risk that people can run out of money. Scheme pensions get talked about much more than they are used.

Smith-Hughes: One thing that may happen is that if HMRC spot something that looks like people are stripping their fund out then they could move to stop it. We need to look at how some of the providers are marketing scheme pensions and make sure they are not breaking the spirit of the rules. 

Morrissey: With regards to Lincoln - people can remain invested in your product post age 75. Have you seen any noticeable increase in the number of people looking to do this?

O’Connor: We have seen a growth in the business we are writing as more people look to use investment linked annuities as they have seen their pot size decrease. That is the big driver. As far as the bulk of the business goes, people want to take an income and want to remain certain it will last as well as being able to remain invested.

Smith-Hughes: One market we have found with asset backed annuities is where people have been in drawdown and are heading towards 75. They want to stay invested but do not like the idea of ASP or scheme pension. There is a large market there.

Goodey: The thing people do not appreciate is the mortality cross subsidy that you get with annuities. You do not get that in drawdown and people need to take that into consideration.

Burrows: I have a few clients who enjoyed running their own SIPPs and many of these people want to stay invested so an investment linked annuity fits them well. Another way of looking at retirement is as a transition. At 60-65 they do not want to lose control of their assets but as time goes on they may look to decrease risk and maybe move the majority of their money into an annuity. They do not have to convert all of their money into one product on one particular day. One issue with drawdown is the older you get the greater return you need to overcome the mortality drag – precisely the time when you do not want to take on more risk.

Morrissey: I was at an event where the conservative pension spokesman Nigel Waterson was discussing the Age 75 rule – where do we need to go with this?

Smith-Hughes: Moving the rule would give people more choice but there are other factors that also need to be considered. For example will moving the age 75 rule enable people to continue contributions and gain tax relief? Also, if you allow people to stay in drawdown forever do you allow them to stay in value protected annuities also past 75?

Goodey: The mortality cross subsidy really starts to bite at 70 and people need to realise that. Removing it will give more choice but people need to understand all aspects of that choice.

Burrows: They need to abolish it for a number of reasons. It is a blight on financial planning. How do you have a long-term investment strategy in your 70s if you know you have to make a decision at 75? Many people are hoping that a change of government will bring a change of rules.

Morrissey: How do we see the annuity market developing from here?

Tinsley: For me you have got three main segments – small funds up to 25,000, the £25-£100,000 bracket and then the large funds. We need more innovation in this middle section and we need to be smarter in how we administer smaller funds. At the larger end, we will see further innovation in the third way products but it is the middle segment where we need to see more innovation.

Burrows: I am interested in the supply and demand argument. The only way the man in the street is going to get better value is by risk sharing either through a with-profits or investment linked environment.

O’Connor: It comes down to innovation. There is a need for innovation and a demand for more options. Variable annuities will work for some of that market but there is room for more innovation. Conventional annuities continue to serve a great purpose but they need to evolve with the times. 

Ahmed: The annuity market will grow as the baby boomers retire and as more and more employers wind down their DB schemes. The annuity will remain the only real choice for those with very small funds but we will see innovation in other parts of the market. If third way annuity providers can tweak their products and make them simpler they could take a bigger share of the retirement income market.

Smith-Hughes: We did a survey of 1,000 people, 35% of which said they would be happy to have some of their fund invested in the market. We need to educate people more about how they can use asset backed annuities investments to meet their needs. It is also important that advisers stay in touch with clients throughout retirement to make sure they have the right advice for their changing circumstances. The in-retirement market is every bit as important as the at-retirement market.

Goodey: Conventional will continue to be the backbone of annuity provision. I think impaired will continue to grow. For me the biggest market to grow will be flexible annuities such as with-profits and investment backed annuities. There are great opportunities here and I think we will see more providers move into this market. 

Adviser profiles

Tuhin Ahmed is account manager at Courtiers

Tuhin joined Courtiers in March 2008, working as an account manager within the corporate client’s team. Tuhin concentrates on advising clients on group risk & pension products but is also involved in planning retirement income strategies.

Prior to joining Courtiers Tuhin spent several years working at Prudential in various departments and roles but focusing mainly in annuities.

Billy Burrows is annuity director at William Burrows Annuities

Billy runs William Burrows Annuities and provides advice to individual clients and pension schemes on all aspects of annuities and drawdown. In addition he provides consultancy services to insurance companies as well as running the popular annuity website www.williamburrows.com.

His interest in annuities goes back to 1993 when he helped establish Annuity Direct. In 1997 he set up William Burrows Annuities in 1997, and a year later he was asked to join Prudential Annuities as their marketing director for annuities. In 2001, William Burrows Annuities was re-established in partnership with Aspen (Actuaries and Pension Consultants) plc.

In 2007, following the sale of Aspen plc to Capita, William Burrows Annuities became a trading name of MPL Wealth Management.

Robert Tinsley is head of retirement services at Origen 

Tinsley’s role includes development of their ‘at-retirement’ proposition as well as managing existing and developing new introducers. He has over 25 years’ industry experience and has held a number of senior positions at AEGON including pensions development manager, branch manager and national development director. He was previously a director at the Aurora Financial Group before the business was acquired by AEGON UK which led to the formation of Origen. 

Provider profiles

Vince Smith-Hughes is head of business development for retirement income at the Prudential

Vince has worked in the financial services profession for over 25 years, and has previous experience as an IFA as well as holding senior pension roles at Clerical Medical and Winterthur Life. Vince is an experienced platform presenter at industry events and a regular contributor to trade publications on all matters relating to retirement income issues. 

About Prudential

Prudential is the UK’s largest annuity provider – supplying one in four people with their annuity and paying out more than £2 billion in retirement income every year. 

Prudential has one of the UK’s largest with-profits funds, looking after more than £57 billion (as at December 2008) for its investors. In total the Group has over £256 billion under management (as at 30 June 2008), looked after by more than 500 investment professionals around the world. 

Prudential’s range of retirement solutions includes the income choice annuity, the with-profit annuity, the flexible lifetime annuity, conventional and enhanced annuities and income drawdown arrangements.

Aston Goodey is director of sales and marketing at MGM Advantage

Prior to moving to MGM last year, Aston was annuities business development director at Prudential. 

About MGM Advantage

MGM Advantage is a new name in the UK retirement income market. Formerly known as MGM Assurance, the company repositioned itself as MGM Advantage in June 2008, when it launched a wholly-owned business unit called MGM Advantage Designs for Retirement to focus on annuity sales and the wider retirement income market. MGM has been registered longer than any other company in the UK. It is a mutual society owned by its members, and manages assets in excess of £1.4 billion. MGM Advantage’s commitment to customer satisfaction is backed up by a customer charter, which promises high quality service and ease of mind.

Simon O’Connor is head of products and marketing at Lincoln Financial Group

Simon O’Connor joined Lincoln in early 2007 as head of product and marketing with Lincoln Financial Group. He was previously pensions product manager at Legal & General, where he spent 19 years. He joined Lincoln after a career break spent living in Europe.

About Lincoln Financial Group

Lincoln is passionate about doing the best for its customers at or in retirement, by bringing to the market reliable and flexible solutions which enable a smooth transition through retirement, protecting and enhancing wealth to enjoy an income for life. Lincoln serves the needs of customers nationwide through financial advisers and is dedicated to building excellent customer service. In 2007 Lincoln launched a new innovative range of retirement products to build on its protection and investment products. To contact Lincoln, telephone 0845 605 2323, or visit www.lincolnuk.co.uk.