Each month, we ask our industry to answer one big question!
Nigel Barlow is head of retirement income solutions at Just Retirement
The issues of risk acceptance and return dominate considerations for unsecured pensions. Providing a reasonable level of income for a lifetime is reliant on a rate of return the pursuit of which could endanger an individual's standard of living due to the risk involved.
In effect the variable annuity sets a limit on the risk that has to be borne to achieve the required return. This limit comes at a price, increasing the gross return required. If your concern is to maximise income in retirement, the cost makes the variable annuity less attractive, especially in a low return environment. The critical yield required to match an annuity will be much harder to achieve under these circumstances.
Over a 30 year period with a 5% withdrawal rate, the probability of a non-guaranteed fund being depleted, and thus of having no income, is very small but it is not zero. This event may be unlikely, but if it happens it will hurt. How much one is willing to pay to avoid this is a matter between client and adviser.
Nick Bladen is head of pensions & bonds marketing at Skandi
With all product recommendations, the adviser will select the product most suited to the client's needs and a cautious client may be happy to pay for the security they feel is offered by a guarantee.
What is questionable is whether providers of variable annuities could take advantage of this cautious approach. Where it is difficult to see the value being offered to the client, determining the cost of any guarantees could see a provider putting a price on peace of mind.
It is possible that a proportion of clients will never see the benefit of the guarantee they have paid. It therefore becomes a lottery as to which clients will get value for money.
The costs associated with variable annuities are not always easy to quantify, as future guarantees may vary subject to policy terms. Clients may therefore be puzzled as to how future costs are varied and how this may impact the level of income being provided.
Price is only one factor to be considered and with clients requiring a tailored and suitable solution, all solutions must be considered. There is undoubtedly a market for this type of product in the US. Only time will tell if the UK market follows suit.
Peter Carter is head of product marketing at Met Life UK
The research talks about 'variable annuities' without really defining what they are. That's perhaps not surprising as 'variable annuities' in the UK market appear to mean different things to different people.
Advisers and providers should instead be talking about unit-linked guarantees - products which offer capital and income guarantees with the flexibility to opt into guarantees when required.
The variable annuities the research is talking about come with guarantees as an integral part of the product and do not offer the chance to opt in and effectively future proof your investments.
MetLife's new Retirement Portfolio offers guarantees starting from 0.5% a year which is highly competitive when ranked against existing products such as drawdown. Investors can benefit from 100% performance lock-ins every three years.
Unit-linked guarantees are not the solution for all retirement savers and there will always be a place for other products. The argument that high costs are the major barrier to using unit-linked guarantees should however be regarded as over.
David Dunn is head of retirement planning at Fidelity International
Variable annuities, perhaps more than any other product available, better mitigate or eliminate completely the risks people face in retirement. It is little wonder that these products have achieved phenomenal success in the US and Japan. They provide a guaranteed income for life with the prospect of regular increases to help combat inflation. The underlying investments can still be held in a mix of assets and, outside of a pension wrapper, assets can still be accessed and passed on after death. It is a highly compelling consumer proposition.
However, our own analysis suggests that the additional charges applied to these products are significant when measured against the likelihood of the guarantee coming into play. Therefore it is difficult not to conclude that the costs of the guarantee appear expensive.
However, value is in the eye of the beholder and many people feel that the peace of mind they offer is worth every penny. At the same time, people who do not need absolute guarantees, possibly because a significant amount of their retirement income is already guaranteed (via a DB scheme for example), may be better off with alternative solutions.
In short, different people will favour different products, guaranteed and non-guaranteed, and cost will be only one of a number of reasons influencing their preference.
Bernard Footitt is technical manager (pensions) at Canada Life
First of all, it is important to understand that the term 'variable annuity' is meaningless in the context of the UK pension environment - these arrangements are just pension fund withdrawal plans (unsecured pension) with optional guarantee riders.
The advent of these arrangements was the stimulus for this research piece, 'The nature of financial risk in retirement: Are guarantees the answer?' (October 2007); a small part of which considered the cost vs. value for money argument. In the introduction, Simon Fraser (President: Institutional Business, Fidelity International) wrote, "Our conclusion is unambiguous: while the emotional value of guarantees is unquestionable we believe in pure economic terms the current generation of products provides poor value for money."
Finally, the research shows that if your funds are more conservatively invested (40% equities/60% bonds), then you would "give up more than half your capital to cover a risk that would have only a 1-in-70 chance of occurring after 30 years".
Even though the researchers are at pains to say that their guaranteed drawdown construct is basic with just a Guaranteed Minimum Income Benefit, and that some actual products are less expensive than the 1% guarantee charge, while some are more expensive; the clear conclusion is that "the current generation of products provides poor value for money."
I think it's fair to say that I too think the associated cost is not justified in these products as retirement income arrangements.
Andrew Gadd is head of research at The Lighthouse Group
At the end of the day the cost of any 'guarantee' is only one factor in any investment decision. It will only be with the benefit of hindsight that anybody will be able to say with any confidence whether the cost of a guarantee was justified. Even with, for example, 'standard' annuities the difference in income between an inflation linked and non inflation annuity can be significant at the start and it is only over the term of the investment that it becomes clear whether this 'cost' was worthwhile. It is however, essential that the structure of any product being recommended to an investor is fully, and clearly, explained at the outset with the reasons for the recommendation and the discounting of alternatives also fully documented.
Aston Goodey is head of business development - retirement income at Prudential
The Fidelity research said that the cost would be perceived as being too high by most people, but we believe that despite this perception, some people still want peace of mind and will pay for it. It's not yet clear if the wider market is ready to embrace the charges for the guarantees they offer, and many of the larger providers (including Prudential) are keeping a close watch on how the market develops. What is increasingly evident is that there is a real need for customers to access 'real' assets while limiting their risk profile, and there are already several solutions in the market place to help customers.
Mike Morrison is pension strategy manager at Winterthur
Conventional annuities offer insurance against living too long but no flexibility of income. Drawdown offers flexibility but is subject to investment markets. Variable annuities offer some flexibility with the possibility of guaranteeing income and/or capital - but at a price.
The market for variable annuities has still not been quantified in the UK, although a recent Watson Wyatt report concluded that the market could grow between £2.5bn and £7.5bn over the next nine years, depending on the speed of market growth.
As such products develop I am sure that the value of guarantees will become more evident. The question is to what extent will variable annuities find their place in the UK market between the smaller fund for whom annuitisation is likely to be the right answer and the larger funds that will use drawdown but for whom maximum income and guarantees will not be an issue.
Ian Naismith is head of pensions market development at Scottish Widows
Variable annuities are best seen as a form of insurance. In most cases the insurance premium, which in this case is an additional annual charge, is lost, but if things go badly wrong the insurance can have great value. The cost of this particular insurance is currently high because of market conditions, and for most people a combination of unsecured pension and annuity is likely to meet their needs at lower cost. However, for those who value what variable annuities offer, which is principally flexibility for the future with a minimum income guarantee, the cost may be worthwhile. It is likely to remain a niche product until costs fall.
Simon O'Connor is retirement income head of product and marketing at Lincoln Financia
I think there are two important aspects of this that I would fundamentally disagree with.
Firstly, that the costs are high. I would argue that they reflect the value and nature of the guarantees that they provide. Clearly, a contract with a guarantee will cost more than a contract without one and I don't see that consumers would expect otherwise.
This feeds into my second objection, that the costs are not justified. We are talking about the security of customers' pension income in a world where increasing longevity means that a retirement of 25 or 30 years is a real possibility and where being able to remain invested throughout that time is the only real option if income is to keep pace with inflation.
So, contracts like ours that enable customers to remain fully invested and also guard against significant market downturns provide clear peace of mind. How much is that worth?
Andrew Tully is senior pensions policy manager at Standard Life
The key issue here is value for money, not price in isolation. Guarantees give people the opportunity to remain invested in potentially higher yielding equities. If the additional return achieved by staying in equities is greater than the cost of the guarantee then people will benefit.
Many people use 'lifestyle' options which result in clients moving out of equities and into gilts - even though they may have 30 years to live. By utilising a guarantee this switching will not be required and people can be significantly better off.
Also, many customers invest when markets are high and disinvest when markets are depressed. Having a guarantee can change this behaviour and protect people from poor investment decisions.
Value for money rather than just a focus on charges is the key. If people believe the guarantee is over-priced relative to what it offers then the answer is simple. Don't buy it. Take drawdown and personally bear the investment and mortality risk, or buy an annuity and lock into low yield gilts and bonds for 30 years.
Rachel Vahey is head of pensions development at AEGON
Variable annuities are insurance products and the client pays an insurance premium to cover the cost of providing the guarantee. To provide the guarantee an insurance company must buy and hold appropriate assets on its balance sheet to protect it against market movements. With income guarantees it must also consider longevity increases and price in the fact that the income will be paid for the lifetime of the policyholder. Guarantees give peace of mind but how do you decide if the added cost is value for money? Peace of mind is hard to put a price on and is a very personal thing. Some will be prepared to live with investment risk while others will want to pay for the certainty of guaranteed returns.
Adam Wrench is product development manager at London & Colonial
The idea that third way variable annuities are good value for money is a contentious issue but isn't the main point here that clients are simply paying for peace of mind, in a similar way to insurance?
The only difference with variable annuities in the drawdown space compared with SIPPs appears to be the availability of the optional guarantees. Can the guarantees be provided more cost effective by a multi provider approach? It has been suggested that an unbundled approach using separate providers for life cover, temporary annuity and SIPP investment could be better value than the packaged variable annuity approach. It has also been suggested that using investment SWAPS within a pensions wrapper could deliver similar guarantees without the complex approach of dynamic hedge funding.
Whatever approach taken will require an increasingly educated adviser who will need to possess a sophisticated understanding of these products if the miss-selling scandals of their US predecessors are to be avoided.
Paul Bruns and Elaine Parkes
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