The next big thing

Mark Stopard discusses the future prospects for variable annuities in the UK

It is fair to say that while the likes of Japan and North America have embraced flexible retirement solutions, in the UK the concept is still in its early stages. The typical picture in the UK is that consumers’ lack of awareness results in conventional annuities being selected by default.

News from MGM Advantage* stated that annuity rates fell by an average of over 1.5% in the second half of 2009. This drop underlines the need for consumers and advisers to explore all the options open to them ‘at retirement’, which includes drawdown and more flexible retirement solutions. Encouragingly, recent findings from research conducted on behalf of Sun Life Financial of Canada show that advisers are beginning to explore these options.

Findings from our survey of 262 UK IFAs carried out in late 2009, reveal that around half of advisers (47%) feel that the variable annuity market is gradually building support in the UK, with 16% of those surveyed thinking it is ‘up and coming’. Longevity is increasing, the retirement age is in the process of being pushed back and consumers are demanding more from their later years. For many people, flexible retirement products, that provide a guaranteed income while remaining invested and capturing upside, are now very attractive. But this is only part of the story.

Three stages of retirement

Looking at most retirees, one would be likely to find the following three typical stages: a ‘honeymoon period’ at the start of retirement when spending will peak; ‘mid-retirement’ when spending reduces as individuals become less active; and ‘late-retirement’ when spending increases again to cover household bills and healthcare.

Based on this, it’s easy to see why the UK’s most common choice of retirement income product, the conventional annuity, may be falling short of retirement expectations. Conventional annuities simply don’t offer individuals the freedom to manage their pension fund in the way they want to, neither do they offer the flexibility to increase income when it’s needed and decrease income when the need is reduced.

A retiree in a conventional annuity is also particularly vulnerable to inflation. When locked into a fixed income, spending power can only worsen as the retiree gets older – just when they need the income most – it would be like taking a job for 30 years with no pay rise. For a retirement spanning this period of time or more the impact could be considerable and would lead to noticeable income shortfalls.

Bearing this reality in mind, it is interesting that only one in ten advisers have doubts about the variable market taking off. Sentiment for market growth is strong, with over half (55%) expecting more and more advisers to ‘catch on to the benefits’ of flexible retirement products in the coming years, and the majority (72%) predicting new providers to enter the market.

Conventional vs variable annuities

Unlike conventional annuities, variable annuities can be tailored to suit an individual’s spending habits. Not only do they allow the individual to select the level of income they need, but they also make it possible to take one-off payments to help cover any unexpected costs (within HMRC limits).

A variable annuity also offers the opportunity to stay invested, which can help a retiree address the risk of inflation eating into the value of their fund. Of course, having spent time building up their pension, most won’t want to be worried about losing income due to unexpected economic turmoil or poor investment returns. These people may benefit from adding an income guarantee to their plans, this protects against uncertainty, effectively removing any risk of poor investment performance taking away essential retirement income.

Unlike conventional annuities or drawdown, the options available under variable annuities continue beyond age 75. Bearing in mind that longevity is increasing with every generation, the time spent in retirement will also increase, presenting an ideal opportunity for financial advisers to generate long-term business revenue through the provision of continual annual reviews and advice to their clients.

Our findings show that the IFA market is readying itself for an increased focus on variable annuities, as clients’ needs become more demanding about what they can expect pre-, at- and post-retirement.

A gap has emerged in the UK market which traditional solutions such as the conventional annuity have not been able to fill. This may be about to change.

*MGM Advantage, http://www.mgmadvantage.com/media_centre/Press-Release-21.htm

Mark Stopard is head of marketing at Sun Life Financial of Canada