Intermediaries should look on the new statutory money purchase illustrations as an opportunity to extend market share by preparing their clients well in advance for any shortfalls they may be likely to face
Clients with money purchase pensions are in for a big shock when they receive their first statutory money purchase illustrations (SMPIs). Advisers need to be well prepared to deal with anxious enquiries and to make the most of the potential for increasing contributions.
From April the annual statement from providers must show the real value, in today's prices, of the income clients can expect to buy with their pension fund at retirement. Where clients are used to seeing statements that simply provide their current fund value, this figure for the inflation-adjusted annual income may be half of what they were expecting, possibly less.
For once this is a deliberate shock tactic on the part of the Government. It hopes these new-style statements will act as a clarion call to prompt people to increase contributions to a more realistic level. Under the present rules providers are only obliged to show the current fund value in the annual statement. This gives no indication of what the fund might buy at retirement allowing for an inflation-adjusted rate of return in the accrual period and the purchase of an inflation-linked annuity at retirement.
Advisers who tackle the approaching crisis on a proactive basis may well increase revenue. An initial mailing to all pensions clients that explains the major change in the format of the statements from the 2003-2004 tax year could be followed up with personalised letters and an invitation to a pension planning meeting. Well-prepared shortfall analysis should lead to further sales as clients acknowledge the need to increase contributions.
Fortunately, the statements will not all arrive in one hit, so this gives advisers time to plan the additional work. Pension providers usually despatch the annual statement within three months of the anniversary of the date the plan was started. Money purchase company schemes send the annual statements to all members at the end of the scheme year, which is set by the trustees when the scheme first starts.
The shortfall analysis will need to take into account the number of years to retirement. SMPI calculations assume 2.5% inflation between the statement date and retirement, and a maximum real return of 4.5% for equity funds (less for other asset classes). In addition, it assumes that the annuity purchased at the expected retirement date rises in line with retail prices.
Stewart Ritchie, pensions development director at Scottish Equitable, says: 'This does not mean clients will have to buy an RPI-linked annuity, but the object of the exercise is to show the approximate buying power of the fund throughout retirement not just at the date the client retires.'
The initial income from an RPI-linked annuity is typically 30% less than a level annuity. Moreover, unless the client states otherwise, the calculation is likely to include the cost of a spouse's pension worth 50% of the annuitant's. This would further reduce the annuity rate by 10%-15%.
Based on figures provided by the Annuity Bureau, a man age 60 with a £100,000 fund could buy a level single life annuity that would currently provide about £6,500 a year. Under the new rules the income shown would be £4,200, allowing for the RPI annuity link and the 50% spouse's pension. This reduces the income by almost 40%. If the client is some way off retirement and the projected fund is £100,000 the income would be discounted back to allow for 2.5% annual inflation. This could knock another 10%-20% or more off the client's expected income depending on the remaining investment period.
Clearly these statements will only provide a broad-brush estimate of a client's retirement income. Unlike final salary schemes, where the pension is a known quantity based on salary at retirement and the number of years membership, money purchase pensions rely on a range of unpredictable factors. In particular it is impossible to predict equity returns and long-dated gilt yield, so the fund size and the 'exchange rate' between the fund and the annuity income can only be estimated.
Ritchie argues that SMPI is a significant step forward, despite the inevitable inaccuracies from this one-size-fits-all approach. 'There are no intentional margins in the calculations, as high precision in money purchase illustrations is spurious. I hope that once people get over the shock, they will take this as a call to action. Even if they don't, it cannot be right to shield people from the reality of their money purchase pension provision.'
Many clients will have both money purchase and final salary pensions, so what they really need to see is the whole picture. Aqera, the software provider of online money purchase illustrations (see box), which was responsible for The Exchange, among other systems, argues that the Government must bring in total pension statements that would incorporate the state and final salary schemes, as well as money purchase arrangements.
Ed Holt, managing director of Aqera, says: 'For composite pension forecasts to work there needs to be an independent clearing house that can collect data from pension providers, employers, pension administrators and the state scheme. The system would assimilate the information and provide the combined statement by post or online. The technology is available now and with funding from the Department for Work and Pensions a workable system could be up and running within a year.'
The deadline for the first SMPI statements means that life offices have less than 12 months to design and test new computer software. Moreover, by April or May the Financial Services Authority is expected to publish a consultation paper in response to SMPI, which is likely to require changes to new business illustrations. Aqera's vision is for the outsourced infrastructure to be available on an industry-wide basis so that the cost doesn't add significantly to the financial burden already faced by life offices.
Clients will need urgent advice when they receive the 2003-2004 pension statement.
Well-prepared shortfall analysis should lead to an increase in premiums.
The Government's next move should be to require statements that show state, company and individual pensions.
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