Variety is the spice of retirement life

Philip Brown and Simon O’Connor discuss with Helen Morrissey how variable annuities are regarded within the market and whether new products are likely to be able to make an impact

One key issue advisers have had with variable annuities is that they are complicated and it is difficult to compare products. How is this situation changing?

BROWN: This is an interesting area of advice and one that is difficult to generalise about too much. The key issue comes back to customer needs and ultimately the average fund value. The full suite of retirement options may be appropriate to customers with higher fund values; for example those who may be considering income drawdown.
Customers with funds large enough to consider alternative options such as taking investment risk can clearly do so by seeking advice from an IFA. For the vast majority of customers and those with smaller fund values, annuities provide the type of certainty and guarantee that they really need.

O'CONNOR: At a customer level variable annuities are simple. They provide potential for a growing income from equities with a known guaranteed minimum level of income if things go wrong, as seen in the last 18 months.
Advisers who are able to explain, present, and position the whole of the market to clients, in an efficient and effective manner will have winning formulas - and we have tried to help advisers to help them understand where variable annuity products sit and when they should be considered.
We have attended numerous industry events, and worked closely with the media to promote the benefits. We have provided technical training for advisers up and down the country, and we encourage advisers to talk to us so that we can help them identify sales opportunities in existing client books.
However, we know that in other countries simplified products have been launched as these are better suited to the current economic conditions and this may be a development that we see in the UK in the future."

Would you say there is a target customer for variable annuities?

BROWN: Like guaranteed investment products in the investment market, variable annuities have a place in the annuity market as they sit between conventional annuities and income drawdown. Because of this, they are in my view most suitable for customers with higher fund values i.e. those who may be considering income drawdown. The main issue for lower fund values, in my view, is the cost of the guarantee and therefore, the required investment return needed to actually achieve higher returns - all of which needs explaining very clearly to customers.
In the current market conditions where there are periods of extreme volatility they may seem less attractive to some of the end customers. It is always worth remembering that the average pension fund size at retirement is relatively modest, £30,000 according to ABI data, and anyone below the average needs two things - simplicity and certainty, which is what a conventional annuity provides.

O'CONNOR: The target customer for a variable annuity is one whose needs and risk profile suggest that a conventional annuity does not offer enough and for whom pure drawdown is too risky.
A candidate for a variable annuity would typically be aged 50+ with a pension pot of over £100,000, looking for greater income flexibility and growth potential than that offered by a conventional annuity.
At the same time however, they may be wary about any remaining exposure to equities and have reservations about traditional income withdrawal. In this case, such clients would find the guarantee options offered by variable annuity providers valuable allowing them to enjoy the best of both worlds throughout their retirement.

Variable annuities are often seen as a high net worth solution. Can you see products being developed for those with smaller pension pots?

BROWN: I struggle to see why customers with smaller pension fund values would be considering taking additional investment risk with their pension fund assets. In my view, what customers with smaller pension fund values appreciate, and need, is certainty of income.
For these customers, it is worth fully exploring the enhanced annuity options and focusing on additional income that can be produced from their smaller pension funds, rather than adding the additional costs associated with variable annuity guarantees. I don't believe there is value in adding the issue of investment risk that is associated with investment linked annuities and the concerns/worries that come with the investment dimension.
It is also worth noting, however, that the cost of the guarantees has escalated over the last twelve months and for smaller pension funds this may seem a disproportionally high cost. Surely customers who are interested in death benefits can just consider something much simpler like adding value protection to their annuity.

O'CONNOR: Variable annuities should be suitable for people of all profiles, especially as longevity and low interest rates continue to drive down the value of conventional annuities.
Many of the issues facing today's pensioners are the same regardless of their pot size. While income withdrawal is likely to remain too risky for those with smaller pension funds who do not have other sources of income to fall back on, a simplified variable annuity product offering an underlying income guarantee could offer a viable alternative to a conventional annuity.

Do you think it is likely that we will see new providers entering the market soon? What factors would need to be in place for this to happen?

BROWN: I think there will be new entrants to the market but it is quite hard to put a timeframe around this due to the continued volatility in capital markets. The main issue that remains, in my view, is the cost of the guarantee and therefore, the required investment return needed to actually achieve higher returns - all of which needs explaining to customers. When you add the fact that the cost of guarantees for variable annuities is increasing and more pronounced volatility in markets has been present for several months it make things more difficult for these products.

O'CONNOR: It is very likely that other big providers will enter the market over the next 12 months. Indeed, several product providers have openly expressed an interest in this market in recent months.
The barrier to entry over the last year has been the extreme level of volatility in the investment markets and had we not seen these unprecedented levels of turmoil I have no doubt that other providers would have already launched products in this space. However, as this volatility subsides, the door will once more open to allow new entrants.
The cost of providing guarantees has also increased since the variable annuity market in the UK opened up and many providers repriced their guarantees accordingly. Once again though, as markets stabilise, so too does the underlying cost of providing a guarantee. This will make it a more attractive proposition for new entrants.

How do you see the demand for variable annuities developing over the coming year or so?

BROWN: Investment based annuity and income drawdown have been around for quite a while now. Adding variable annuities to these existing options provide some new choices to customers with larger fund values who would be looking into those options.
The main thing that is really needed for further development of the variable annuities is some transaction volumes.
However, this is only possible if the adviser has a number of customers where it is established as what the customer actually needs/wants and from the options available, and based on their fund size and risk appetite, the variable annuity is the best option.

O'CONNOR: Sales of variable annuities have remained resilient in 2009 despite consumers having to navigate through some turbulent market conditions and the unexpected withdrawal of one of the leading providers due to corporate issues in the US. This resilience suggests that demand for such products remains very encouraging. Sales exceeded £1 billion in 2008; more than double that of the previous year, according to Watson Wyatt research.
In fact the key strength and differentiator of these products - their various underlying guarantees - became more apparent during the volatility. With markets now entering a period of relative calm, it is reasonable to assume there will be another step up in volume sales over the next year. It is also reasonable to assume this will be similar in scale to the growth seen at similar stages in the US and Japan. It is apparent that there is demand for variable annuities both for consumers approaching and at their retirement.
In the fourth quarter of 2008, 40% of premiums came from consumers aged up to 60 years, which may dispel some perceptions that this is only a product for those at retirement. With wider cross-sections of the population and financial adviser community starting to realise the benefits of variable annuities, demand is likely to encourage further new entrants to this expanding market in 2010.

Simon O'Connor Head of products and marketing Lincoln Financial Group
Simon O'Connor joined Lincoln Financial Group in early 2007 as head of product and marketing. 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 and writing.

About Lincoln Financial Group
Lincoln Financial Group is well established in the UK and is part of the global Sun Life Financial of Canada group. Sun Life Financial of Canada is focused on providing high quality customer service and fair investment returns for our customers in the UK, a commitment that dates back to 1893.

Philip Brown Head of retirement products Partnership
Philip Brown has spent the majority of his career providing technical guidance to advisers, intermediaries and consumers on at- and in- retirement planning solutions. Phil has been head of retirement products at Partnership for nearly two years and has more than 20 years of experience within the financial services industry. Prior to joining Partnership, he was head of technical administration for Teachers Assurance and also spent time previously as a senior policy associate for the FSA.

About Partnership
Partnership is one of the UK's leading providers of financial solutions for people whose health and lifestyle may result in a reduced life expectancy. We can offer enhanced annuities to everyone from smokers and people with everyday conditions, like hypertension, to those with serious illnesses such as cancer and heart disease.
Telephone: 0845 108 7237
Email: info@partnership.co.uk
Website: www.partnership.co.uk