Providers must clearly explain the complexities and risks third-way pensions (variable annuities) pose to potential customers and advisers, urges actuary Watson Wyatt.
The consultancy's comments follow market speculation on the suitability of variable annuities; particularly the potential for higher ongoing charges compared with other pension products.
Variable annuities give customers equity exposure and guarantees on the level of income the product pays. However, Scott Robinson, a consulting actuary at Watson Wyatt, says customers remain unclear on whether they would get enough value from the guarantees to justify the 3% charges on the products.
Watson Wyatt highlights guaranteed income bonds and guaranteed equity bonds as creating similar confusion. It says guaranteed product providers perform scenario tests to assess the likelihood of products generating the returns customers would expect and says variable annuity providers could do the same.
Robinson says: "It might also include back-testing to see how the product would have performed in past markets. Communication to financial advisers of the broad results could help to explain the risks and aid understanding of the type of customer characteristics that make the product suitable."
Watson Wyatt says advisers believe the products would need to provide 8% to 9% annual returns just to stand still. However, the consultancy says this provides a good example of how advisers and customers can misunderstand the products.
It highlights gains achieved in good performance years lock in as guarantees protect the poor performance years, meaning the actual return required does not become as high as the formula of charges plus the guaranteed return.
Robinson says: "The different options and guarantees available under variable annuities do make them more complicated to understand than existing more traditional products.
"However, these features and their associated charges do not necessarily make them unsuitable for the UK market. Advisers need to be aware of the risks associated with the products, and therefore what this means for the suitability of the product for different customers."
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