People living longer has led to a rapid increase in pension products coming on to the market and consumers have never been in a better position to pick a product that suits their lifestyle and retirement needs
There has been much innovation in the annuity market lately with a rash of annuity products developed in the past few years.
According to research conducted by the ABI, more annuity products have been launched onto the market in the past three years than in the previous 10.
For Trevor Mitchell, head of retirement income at Prudential, the engine that has driven the changes in the annuity market has been demographics.
'People are living longer,' he says. 'We have statistics showing that four out of five men who are aged 60 now are going to live beyond age 75. More people are retiring and they are retired for longer. You could potentially be in retirement from 50 to 90 so we've got to come up with new solutions.'
This means that in some cases investors should be taking equity risk for longer. He cites the example of an annuity that increases the amount of time retirees are exposed to equity investment. This may well be more suitable nowadays, he says, as equities are generally expected to perform well over a long period, which would mean a higher level of income can be generated for a longer period of time.
Indeed investment annuities have been, along with lifestyle annuities, one of the areas where innovation has taken place.
Investment-linked annuities fall into two categories, with-profits and unit-linked, while lifestyle annuities focus on the occupation, and health of the retiree.
Innovations on the two types of annuity come from different market sectors says, Peter Quinton, managing director at the Annuity Bureau, a specialist IFA company that offers advice solely on annuities. Investment-linked annuities have come from the large companies as they had the financial expertise and strength to back the product up. For lifestyle annuities it has been the smaller companies which have led the way.
He says: 'For instance the company that first came out with the smokers' annuity was Stalwart Assurance, which was later bought by GE Life, the next smokers' annuity on the market came from Britannic Retirement Solutions and the third came from British Life.' All of them small firms, he notes. 'Since then the bigger players have moved into these markets,' he adds. 'Scottish Widows, Prudential and Norwich Union all offer impaired life annuities now.'
Some of the large providers such as Standard Life, Quinton says, have preferred to stay in the standard annuity market and do not as yet offer impaired life annuities.
Nevertheless there is much more annuity products available than 10 years ago. As a result annuities are becoming far more advice-driven.
Quinton says: 'Compared to 10 years ago the annuity market is much more diverse. In the last decade we've had the first location based annuity, draw down was launched, then smokers' annuities came out, with-profits annuities have been launched, and there are also self-invested annuities and occupation-based annuities.'
A decade ago it was a matter of simply shopping around for the best rate whereas now retirees have many more decisions to go through.
'Now it is a question of should I be getting an investment-linked annuity? Should I get an annuity straight away? Should I be doing drawdown?' he says.
This has all served to drive up costs for the consumer which means it is even more important that the retirees secure the best annuity for their circumstances, Quinton stresses.
Late last year saw the launch of the first 'cash back' annuity from Australian financial group Challenger, aimed at the top end of the pensions market. Called the Challenger Open Annuity, and created by London & Colonial, this product keeps an annuitant's pension pot of capital separate from the pots of other annuitants in a segregated fund.
The investor has complete control over this fund including where it is invested, in either unit trusts, Oeics, investment trusts or cash. With money from outside the pension fund, the annuitant then purchases for £1,000 an interest in the fund via a redeemable preference share within the capital structure of the Open Annuity insurer, London & Colonial.
Annuity income payments linked to the performance of the pension fund's underlying investments. Challenger has linked the product to the wrap account provider Transact.
Such flexibility and innovation does not necessarily come cheap. There is an initial fee of 2.25% on the first £1m invested, 1.75% on sums between this and £2.5m and 1.5% on amounts above £2.5m. Among the other charges there is an annual fee of 1.5%, and 0.2% charges for fund switches, on top of fees levied by individual underlying fund managers. The minimum investment for the product is £250,000.
Two companies which are looking to follow Challenger with their own 'cash back' annuities but aimed at the more typical retiree are Prudential and Norwich Union.
Both organisations are currently in talks with the Inland Revenue to see if approval can be given to an annuity product that pays any remaining pension funds in a lump sum to a deceased's estate if they die before their pension fund has been exhausted.
Currently, guaranteed annuities of five and 10 years exist where an income continues to be paid out piecemeal to a deceased's estate if they die within the guaranteed period. However, lump sum payments of remaining capital are not allowed under current legislation and annuity providers will have to wait for a change in law to offer a mass market cash back annuity.
One sticking point the Inland Revenue is thought to have with a cash back annuity is the issue of how to tax any lump sum benefit. Annuity payments attract tax but pension contributions attract tax relief and roll up gross in the fund. The issue for the Government is how to tax any lump sum that would go to a deceased's estate and at what level.
Prudential says it is in the advanced stages of developing its cash back annuity and is simply awaiting approval from the Inland Revenue to launch the product.
The company expects rates for the cash back annuity to offer a 60 year old male with a £100,000 sum a yearly income of £7,375. This compares to the £7,671 per annum on Prudential's single life no guarantee annuity to the same individual with £100,000.
For Quinton, further changes to the annuity market are likely to be refinements to existing products rather than brand new ones.
'There is a limit to how much more innovation can be done. You'll probably see more combined annuities such as an occupation-based smoker annuity,' he says.
Pricing across the range of impaired life annuities available from the various providers is not yet consistent he believes. 'As this market develops we'll probably see a settling down of prices.'
Mitchell at Prudential believes the trend is towards tailoring products to the individual needs of the customer. 'That means making the product more flexible and giving the customer more choice,' he says.
One factor which may provide a further spur to annuity innovation is the FSA rules stipulating that companies have to make consumers aware of their open market option ' their right to shop around for their annuity and not necessarily buy it from their pension provider.
While all retirees are free to shop around for their annuity, according to Mori Poll research commissioned by Britannic Retirement Solutions, only around one third are aware of this and go on to buy their annuity elsewhere.
If more consumers are made aware of their open market option this will probably increase competition among the annuity providers both Quinton and Mitchell believe.
Already competition is fierce with not much to distinguish the top providers, says Quinton. Increased competition will only mean companies that wish to remain in the market will have to find new ways of offering annuities.
'It's a market where you need mortality expertise, investment expertise and financial strength,' says Mitchell. 'Companies are going to have to decide how they are going to provide competitive rates for their retirees. They may do it in partnerships with other companies or they may decide to fully enter the annuity market.'
Growing innovation in market driven by people living longer.
Need for those who are retired to take equity risk for longer.
Larger providers have specialised in investment-based annuities.
Niche players have focused on lifestyle products.
Cash back annuities are now being developed but still need Revenue clearance for mainstream product.
Competition in the annuity market is growing.
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