The Big Interview: Vince Smith-Hughes

This month, Vince Smith-Hughes talks to Helen Morrissey about the role asset-backed annuities can play in a retirement planning portfolio

What are the key challenges ­facing retirees and how are these they being met by ­traditional retirement products?
The key challenges we face will be the effect of ­longevity and inflation. About a third of people who retire today at 65 will get to their 90th birthday and the average longevity for women today at 65 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 65-69 age group, this can add an extra 3.3% onto 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.

What role do you see asset backed-annuities, such as the Income Choice Annuity, ­playing in retirement ­planning ­portfolios? How do they meet retirees’ ­challenges, such as the need for flexibility and ­inflation ­hedging?
At the moment, advisers are still ­recommending mainly conventional ­annuities and then doing drawdown with those who can afford to take on more risk. However, they need to pay closer attention to the ­products in the middle of the market as there are other alternatives.

If you look at someone with a £50,000 pot, then they don’t want to take ­investment risk with that. But they shouldn’t be in a position where they either have to have no flexibility or have to take on risk. There needs to be something in the middle.

Asset-backed ­annuities are ­invested in the markets, but they are also still in the ­mortality pool and so you do get a more sustainable income over time. With people’s ­retirement patterns changing, we are seeing more people looking to phase into annuity purchase ­gradually. As a result, they may not need a fixed income.

We could increasingly see people at, say, 70 years old looking to move about 10% of their fund into an annuity while keeping the rest in ­income ­drawdown. In simple terms, drawdown is the right choice for some but asset-backed annuities can help others.

How do these products work and who are they aimed at?
I think the appeal of asset-backed annuities is universal. They are more than just a ­middle ground between conventional ­annuities and ­drawdown. They have a much wider ­application than that and could do a lot of help to those who want more flexibility from their ­income.

For instance, ­someone ­retiring at 60 may want some extra income until 65 and then may want to scale back their income at 65 when their state benefits kick in.
However, they still need to ­understand the risks they take. Prudential’s Income Choice ­Annuity, for example, ­guarantees to pay a ­regular income for life with the ­added benefit being that your ­client’s income has the ­opportunity to grow as it’s linked to the ­performance of our with profits fund. We also guarantee not to pay them less than a certain amount, known as a secure level, no matter how our fund performs.

A key benefit is the growth potential to keep up with ­inflation, especially with people living longer. For instance, all Income Choice ­clients, regardless of when they took out their ­annuity, have seen their income grow at their ­policy anniversary, even if ­the ­maximum income was taken from the outset.

What misconceptions do ­retirees hold about ­asset-backed annuities?
How can these be dispelled?
The general level of ­understanding does need to be improved. Some advisers struggle to work out how to embed these products into a ­retirement planning process.

Prudential is carrying out roadshows at the moment to help advisers get to grips with this. Once this happens, then the market will get bigger. We have historically-low annuity rates at present and there’s no sign of them getting better over the long term, so people need more ­flexibility from their income.

I think we will see more providers come into the asset-backed annuity market over the coming year or so. People like the flexibility that comes with drawdown and it remains a good solution for many. But if you want a simple sustainable solution which offers growth potential and guarantees to pay a regular income for life, then the asset-backed ­annuity can have a role.