The third way has not lost its way

Critics have been quick to predict a bleak outlook for third way providers following The Hartford's decision to withdraw from the UK market and further concerns around the cost of guarantees. However, all the signs are pointing towards a growing market and an even greater need for variable annuities as an effective way of mitigating the risks faced by today's retirees.

A booming market

The retirement market is one of the few sectors showing positive growth and this is largely due to the ageing population and an attractive 'baby boomer' audience. Over the last five years, the annuity market overall has recorded healthy growth of 12% a year while income drawdown has seen 14.9% growth*. This growth has led to increased product innovation as advisers and consumers look for new ways to mitigate the risks now faced in retirement.

This has clearly been welcomed with sales of variable annuities doubling in the past year. Variable annuity premiums grew from £539m in 2007 to £1.15bn last year while the number of policies sold rose by more than 80% from 7,775 to 14,128**. Forecasts from Tillinghast Towers Perrin are also encouraging, predicting a £70.6bn market by 2016***.

Into the spotlight

The economic turmoil has played a big part in this. The combination of falling annuity rates and dramatic fund losses has made conventional annuities look very unattractive for some people. While in contrast, the income growth potential offered by variable annuities alongside the income guarantees has brought them into the spotlight as a very appealing and viable alternative.

There is still a general perception however that conventional annuities are somehow a safer option than variable annuities. This is most likely because they have been around for a lot longer and are more familiar to the majority of people; there is also a sense of security gained from knowing exactly what your income will be for the rest of your life.

Variable annuities on the other hand are new and have a perceived level of complexity around them. Fortunately, the market is recognising the benefits variable annuities have to offer - most notably extreme income flexibility, which makes conventional annuities look a little old hat by comparison. Fuelling the growth of this market is the investment variable annuity providers are putting into promoting the concept of their products to the IFA market, with advertising, training, seminars and press coverage all used to great effect. With further education from providers to improve awareness and understanding of these products, acceptance should become even more widespread.

Opening up to new solutions

Conventional annuities will still be entirely the right solution for some people but advisers are facing increasing pressure from their compliance departments to explore all the options now available to clients - something which should develop the market further. In addition to this, the current climate has placed a greater emphasis on planning for retirement - something which the British public are becoming more conscious about. A report by Lincoln reveals that almost two-thirds of IFA clients are now more concerned about choosing the right annuity for their circumstances****.

A client today could be looking at a retirement lasting thirty years or more and with long retirements comes more risk. Clearly it's not just the client's attitude to investment risk that now needs to be considered. Advisers need to assess the risk of a client outliving their savings; the effect of inflation on their income; the risk of health problems in later life, the resulting cost of long term care and of course the risk of losing a partner.

These problems were there before the current market turmoil and deepening recession, but are even more important now with retirees suffering, not only from their increasing longevity, but also the double whammy of depressed fund levels and worsening annuity rates.

Let's talk numbers

Figures show that income from an annuity is already down by around 10% since July 2008^… and that clients transferring their pensions into a lifetime annuity at retirement face a lower income than those who opt for flexible or drawdown facilities. The difference can be considerable. Research has shown that 70% of people who continue to invest a proportion of their retirement savings after the age of 65 could boost their incomes by up to a third¹.

Variable annuities offer this investment upside alongside an income guarantee option which does have an additional and explicit cost (Lincoln's is 0.95% per year and applies only while the guarantee is switched on) but for a client who may have experienced a fall of 30% or more in their fund value, that increasingly looks like a cost worth paying.

When you look at the facts and figures, it's easy to see why this market has taken off over recent months. With the commitment and support of the providers in this market, Lincoln expects more and more advisers to continue to embrace variable annuities because there are an increasing number of potential clients out there who could be better off in retirement if they do.

Sources:
* Datamonitor, April 2009
** Watson Wyatt, March 2009
*** The Guardian, May 2009
^**** George Street Research carried out an online poll of 202 IFAs in April 2009 Money Marketing, April 2009
¹Rethinking Retirement Income Strategies Report, Citywire, March 2009