Make your retirement income work harder

Helen Morrissey looks at how asset-backed annuities can help retirees meet the challenges of longevity and inflation

Asset-backed annuities have been available for some time, but have yet to gain any real foothold in the UK market. However, there are a variety of factors coming into play that could open up the market over the coming year.

For years, the ­asset-backed ­annuity space was ­populated by just one provider. Canada Life launched its ­Annuity Growth ­Account (AGA) more than a decade ago, and has since been joined by both ­Prudential and MGM Advantage.

However, even these providers are willing to admit that there is a mountain to climb in terms of developing ­adviser ­awareness of these products. But ­Nigel Orange, Canada Life’s ­technical manager, believes recent pension reform forms an ideal basis for this market to develop further.

“To be honest, the ­development of this market has been slow over the past ten years and there hasn’t been much in the way of ­innovation,” he says. “I think there is a lack of awareness from advisers as to what these products can do.

“Providers have to play a more active role in helping ­advisers get to grips with these products as at the moment, they fall into the default option of ­thinking income ­drawdown is the best ­option.

“We need to cultivate more ­understanding of the different options. However, I do think the removal of the Age 75 rule will do a lot to increase the focus on this area and I think we will see more of a level playing field with drawdown.”

Factors contributing to market growth

The removal of the Age 75 rule has injected much needed ­flexibility into many people’s retirement ­planning. In addition, the abolition of the default retirement age means more people are likely to phase into retirement over a number of years.
As a result, we could see people looking to mix and match annuities and drawdown to meet their income needs as they get closer to retirement.

The other key factors coming into play are increasing longevity which, coupled with rising ­inflation, highlight the need for retirees to have an income that increases over time. For those who don’t wish to put all of their money into ­drawdown, asset-backed annuities could play an important role.

“The key challenges we face in this area will be the effect of longevity and inflation,” says Prudential’s head of ­business development Vince Smith-Hughes.

“About a third of people who retire today at 65 will reach their 90th ­birthday, and the average longevity for ­women at 65 today is 20 years.

“We are also seeing inflation making a comeback. The latest RPI is 4.8%, but we know ­inflation for pensioners is higher. It has been ­estimated that in the 65 to 69 age group, this can add an extra 3.3% onto to RPI, so you are ­looking at pensioner inflation of more than 8%.

“However, if you look at the ­annuity market, we can see that 75% of people still buy a ­conventional annuity with 90% ­being purchased on a level basis.

“To an extent, you can ­understand why this happens. If you wanted to take out an RPI-linked annuity, then it will take a long time for the income to catch up with a conventional-­level annuity – you can see why people don’t go down that route. However, people do need an ­increasing income over time to meet their needs.”

The impact of Solvency II

The forthcoming ­Solvency II ­directive also looks set to make asset-backed ­annuities more ­attractive to those who would ordinarily have purchased a ­conventional annuity, according to MGM Advantage’s director of sales and marketing Aston Goodey.

“Annuity rates are dire and Solvency II looks set to see them fall further still,” he says. “But there is still a silver lining in that if rates continue to fall, then so does the required performance of the asset-backed annuity to meet this income.

“This is a clear and simple gamble for the annuitant to get to grips with. The world has certainly changed a lot in recent years. When we had annuity rates of 15%, ­people didn’t purchase asset-backed ­annuities.

“However, they are far more likely to do so now. ­Consumers will ­probably look for alternatives now and they are more tolerant of the risk they need to take.”

These products can also appeal to those who may have ordinarily gone into income drawdown as they will not be fully exposed to the vagaries of the stock-market. This is particularly useful as the retiree ages.