Are variable annuities becoming endangered?

Helen Morrissey asks what the future holds for the variable annuity market and how that will affect the third way sector as a whole

The third way market has expanded rapidly over the past four years with providers developing variable annuities, as well as fixed-term and asset backed annuities.

The reasoning for developing these products has been sound. While many retirees wish to purchase an annuity or go into income drawdown, there remain a large portion of clients who may want more flexibility than an annuity can provide but don’t wish to expose themselves fully to the vagaries of the stockmarket via income drawdown. These third way products go some way towards bridging the gap by enabling retirees to benefit from some degree of market upside while also being able to guarantee part of their income.

However, while there is undoubtedly a case for the development of these products, the third way market, particularly variable annuities, has undergone turbulent times. Advisers have branded these products as being overly complicated while variable annuity providers have been forced to re-price their guarantees in the wake of volatile investment markets. Over the past year or so, the Hartford exited the market and Lincoln Financial was purchased by Sun Life Financial of Canada.

However, just before Christmas Sun Life’s decision to close to new business was a further blow to the market. So, what does the future hold for variable annuities and third way products as a whole? Do these products have a future or will the market wither away?

Ripping up bundles

Annuity Direct’s chief executive Bob Bullivant sees the market as facing many challenges: “There are several issues with variable annuity products,” he says. “First of all, the companies that first brought them to the market were US companies who had track records for coming into the UK market and then pulling out again.

It’s true Aegon are also in the market but there have been no major UK players as yet. The second thing is that these products are devilishly complicated and when you boil it down you can achieve very much the same effect by using annuities and income drawdown and the costs will be less. It’s just a case of ripping apart the bundle and looking at the constituent parts.

If I look at the third way product range in its entirety then the only product that I feel is of note is the Living Time one. I feel it has a variety of uses but even then I feel they underplay the risks of a fall in income once the fixed-term comes to an end.”

Met Life is one of the few remaining providers in the variable annuity market and its head of product marketing Peter Carter, remains positive about the market’s future prospects.

“I don’t know if I would say I was surprised by Sun Life Financial of Canada’s decision to exit the market,” he says. “I would say we were more disappointed as we feel more providers need to come into the market. However, Axa’s decision to enter the market means variable annuities are alive and well and we will continue to see more innovation, not just in the variable annuities but the third way space in general, and I feel this is being driven by strong consumer demand.”

However, he also concedes that these products have needed to be simplified if they are to remain in the market. As a result the company has conducted research to ensure advisers understand the product well enough to recommend it to clients.

Delivering clear messages

“The key to success for us has been making sure the value of the guarantee is as good as it can be,” he says. “We need to deliver clear messages to the client so they understand what this value is. It has taken us some time to get the value proposition right and we did a lot of research with advisers and their clients to determine how they felt.”

Axa Wealth has also looked to make their recently launched product as simple as possible and the company has worked closely with advisers to ensure they understand it. Axa’s decision to enter the variable annuity market has undoubtedly proved to be a boost. The Axa brand is well known in the UK and this could do much to heighten the profile of the products further.

Axa Wealth’s head of pension development Mike Morrison says: “We needed to make sure we were launching our product at the right time. We had to be sure our product would be able to stand its ground in the marketplace. We’ve also looked to take out as much of the complexity as possible and we’ve gone out on roadshows and spoken to people about how the product works.”

Understanding how these products should be used

Increasing understanding of how third way products work will be all important if they are to become embedded within the UK marketplace. Recent changes removing the effective compulsion to annuitise means clients will have more options as to how they take their retirement income, and third way options could play an important part in this. LV=’s head of annuities Matt Trott believes we will no longer have “annuity clients” and “drawdown clients”, advisers will increasingly use a range of products that change according to client needs.

“It’s dangerous to pigeonhole people as customers don’t fit neatly into one area,” he says. “People may want a bit more flexibility to go alongside the stability of an annuity and that’s where the third way products can help. Life expectancy is increasing all the time and peoples’ needs change during the course of their retirement. We need to deliver more flexibility and help customers to better understand their options.”

Axa’s Morrison agrees saying that as people live longer and adopt more flexible working patterns they will need more flexible products to deal with this. 
“Now that the need to annuitise has been abolished we can move away from product oriented retirement planning and move towards a solutions based approach,” he says.

“Many people will continue to purchase annuities but it will be at a later age and they will utilise third way products and drawdown earlier on – it will be more of a journey. Third way product solutions are not trying to be all things to all people – they are part of a kit the adviser can use to put together a retirement strategy. I think advisers and their clients are starting to understand this more and more, and I think third way options will be included in every consultation an adviser has with their client in future.”

The future

So while third way products have undergone difficult times there does seem to be more promising times ahead. While some providers have exited the variable annuity market they are being replaced, while fixed-term and asset backed annuities look to be gaining a foothold in the market. However, providers will need to continue to educate advisers if these products are to flourish.

Annuity Direct’s Bullivant believes this commitment to simplicity and education will be an important factor if these products are to remain in the market.

“We need to keep things simple and stick to concepts that are easy to understand,” he says. “We need to be able to explain these products within a couple of paragraphs. I also think we need to see the big providers such as the Prudential and Aviva entering the market.”

However, recent legislative changes could also prove to be a boost to this market as advisers look to develop solutions that meet their clients need for stability with a degree of flexibility. Met Life’s Carter believes there are plenty of reasons for optimism ahead.

“I think we will need innovation in both the annuity and death benefit area going forward,” he says. “Many clients will continue to purchase annuities while others will continue with income drawdown. However, there will remain a large section in the middle of clients who want a different solution and they could well use third products to help deliver that.”