Unlocking choice

Helen Morrissey assesses the prospects for the fixed term annuity market

The fixed term annuity has, up until now, played a relatively small part in the at-retirement marketplace. Until recently only one provider operated in this area, but the recent entrance of LV=’s Protected Retirement Plan product looks set to bring more focus on this market going forward.

Fixed term annuities enable clients to take out an annuity for a fixed length of time, say 10 years, during which time they can draw a guaranteed rate of income. The client is locked into the terms of the annuity during this time but at the end of the period they are able to redeem the full maturity value of the annuity and can use it to purchase a different annuity elsewhere.

“We decided to launch the product for a number of reasons,” says LV=’s head of annuities Matt Trott. “We could see that the current at-retirement market was polarised between the security of annuities and the flexibility of income drawdown. As people are living and working longer they need access to more flexible retirement solutions and so we aimed to develop a product that takes on board the flexibility of income drawdown with the security of annuities.”

Filling the void

He is joined by Steve Lowe, marketing director of Living Time which had been the only provider operating in this market. According to Lowe, fixed term annuities do much to fill the void between lifetime annuities and income drawdown and he expects the market to grow rapidly.

“The consultant Towers Watson predicted the at-retirement market to grow to £24 billion and I can’t think of another market predicted to grow like this,” he says. “I feel fixed term annuities are the natural substitute to lifetime annuities as we are able to remove the risks associated with drawdown by providing security. At 65, when people reach retirement you could still be in good health so why lock into a lifetime annuity rate if you could live another 30 years? You may not need to draw income at this stage as you may wish to keep working, so why lock into a lifetime annuity? Similarly one in two people suffer from some form of serious illness between 65 and 70 so why lock in as a healthy person and miss out on an enhanced rate? Fixed term annuities enable you to keep your options open and vary your benefits.”

Potential impact

So it would seem that there is potential for fixed term annuities to bring much needed flexibility to people’s retirement planning options. Being able to defer purchasing a lifetime annuity until you have a better idea of your future income requirements will be key for many retirees, and according to Trott, the application of these products can be widened still further to help retirees deal with risks such as inflation.

“I feel fixed term annuities have a variety of applications,” he says. “It could be used by those wanting a bridging income until their state pension comes into payment for instance. It also helps deal with inflation to some extent. I think there’s plenty of scope for this concept to evolve further to take on board different death benefits and investment options but first of all we need to ensure advisers are happy to take on and understand these risks.”

So while the market for fixed term annuities is currently small, there is, according to Living Time’s Lowe immense opportunity for growth. Indeed so confident is Lowe about the prospects of this market that he predicts one in four retirees will be utilising fixed term annuities within the next five years.

However, while it’s cheering to see such optimism, it is not shared across the market. Legal & General’s head of new product development – Annuities Tim Gosden believes that until people truly understand the risks associated with fixed term annuities they will struggle to have mass appeal.

“We think (such figures are) optimistic,” he says. “So many products have claimed to have widespread appeal but have failed to make a real impact. Even sensible alternatives like with-profit annuities have struggled because so many consumers are reluctant to take on any risk.”

What are the risks?

So what are the risks that advisers and their clients need to be aware of when looking at fixed term annuities? According to LV=’s Trott there are two key issues for advisers to bear in mind.

“Firstly, while there is flexibility at the end of the fixed term, it’s important to realise that the income is fixed during that term and the client can’t make changes,” he says. “Similarly, at the end of the term there is a fixed maturity value but this amount is dependent on the prevailing investment conditions.”

However, according to The Annuity Bureau’s proposition director, Tim Whiting, fixed term annuity clients will also be taking a gamble on the future direction of annuity rates as well as their health status if they wish to reap the benefits of using a fixed term annuity.

“Inevitably there is always going to be a catch,” he says. “Will you be better off at the end of the fixed term period? Will the annuity rate have improved? Will you be able to qualify for an impaired annuity? Obviously many people will be able to benefit, but not everyone so you have to go into this contract with your eyes open.”

Adviser understanding

There are also other issues that will need to be addressed if fixed term annuities are to gain real traction in the competitive at-retirement marketplace. One of the most important factors in the success or not of these products will be in advisers’ ability to understand how they work and how they can help their clients. According to Whiting there is still some way to go before the majority of advisers are at this stage.

“It’s still a very mixed picture as I feel that the annuity specialists have a very good understanding of these products but the more generalist IFAs aren’t able to give much time to annuities and so they won’t understand them so well,” he says. “There is a knowledge gap that needs to be addressed and once this has been done then advisers will be able to do more to develop more bespoke solutions for their clients.”

However, according to Lowe, the key challenge will be to get advisers to think beyond the ‘tried and tested’ methods they have always employed and once this has been done then the prospects for fixed term annuities look good.

“If you think about lifetime annuities then IFAs have been selling these for the past 100 years and it takes time to break these habits,” he says. “However, I see nothing but expansion in the fixed term annuity market and I’m pleased to see LV= enter the market.”

Future for fixed term

So what kind of impact will fixed term annuities have? Will they grow to form an important part of the retirement planning marketplace or will they remain on the fringe? According to Whiting, more work needs to be done before their future looks clear.

“I think the market needs to mature and once it does then I think these products could have a real impact on the market once we learn more about what these products can do,” he says.

“However, I do still feel that the bulk of the market will be made up of more traditional products like lifetime annuities.”

Legal & General’s Gosden agrees that fixed term annuities will certainly appeal to some but as yet it will be difficult to assess the true appeal of these products over the long term.

“We are investigating a new product development for the mass market and our research will take into account some of the attributes of fixed term annuities,” he says. “At this time, it is difficult to predict how the fixed term market will develop. Fixed term products are appropriate for some customers but the question is whether they have mass market appeal and will be able to compete head on with the traditional lifetime annuity (standard and enhanced).”

However, according to Lowe these products sit on the cusp of an exciting future and that the entrance of more providers into the market will bring increased innovation to this space.

“I see a lot more innovation to come in this market and we will certainly see more entrants – this in turn will provide better choice for retirees,” he says. “We just need to work with advisers to help them understand what fixed term annuities can do for their clients”

So while fixed term annuities undoubtedly look interesting it is as yet far too early to make any solid predictions about their success. It will be interesting to see if other providers will look to enter this space and there is a huge education piece still to be done with advisers if they are to truly understand how these products work. However, if advisers do get to grips with these products and feel comfortable using them it will be difficult not to see these products making a real impact in future.