Kevin Pacey discusses the challenges for advisers and clients in the at-retirement market and looks at how the increasing choice affects how advisers give advice
In 2007 premiums in the UK pension annuities market were over £11 billion. Over the last 15 years it has tripled in size and, due to an ageing population, this trend is set to continue.
However, demand is not the only thing that is increasing. With more and more defined contribution pension schemes heading for maturity, advisers are being challenged with increasing product choice in the at-retirement market.
The at-retirement market requires advisers to have a solid understanding of the options available and how they suit the client's needs. Only once the exact shape of the annuity has been decided, can a whole of market search for the best rate begin.
However, it's important to realise that the decision should not be led by rates alone; there are a number of things to consider.
Once purchased, the commitment to the annuity is irreversible. It is vital that advisers consider all of the options thoroughly with their clients.
Life expectancy is increasing, which means pension pots have to stretch further to fund the cost of retirement. According to figures from the Office of National Statistics, a 65 year old woman will now live for 2.8 years longer than they would have in 1980, and a 65 year old man will now live for four years longer.
Longevity has resulted in advisers having to deal with increasing demand for products with greater flexibility.
Rising rates of inflation
Advisers must contend with increasing rates of inflation, which affects the purchasing power of the retirement income.
According to research from HBOS, the rate of pensioner inflation has increased by 36% over the past ten years. Advisers need an established knowledge of the variety of products designed to counteract the effects of inflation, these include: with-profits annuities; providing the opportunity for smooth growth in income over the long-term with a minimum income guarantee; unit-linked annuities providing the opportunity for growth by linking the income to the performance of real assets; and flexible annuities that give the potential for growth without locking into a secure income for life.
Increasing product choice
Most advisers are familiar with the long standing annuity products including conventional, unit-linked, with-profits and flexible annuities.
However, in recent years, providers have introduced a range of new at-retirement products including income drawdown and variable annuities. Here's what they are about:
- Income drawdown allows clients to make withdrawals from their pension pot to fund a retirement income before they are ready to buy an annuity. Typically, income drawdown appeals to people with larger pension funds in excess of £50,000 or for those with other sources of income to support them in retirement.
The advantage of income drawdown is that clients can keep their pension fund invested for longer and so have the possibility of increasing potential returns. Furthermore, a client can take 'tax free cash' but no income, leaving the fund to continue to grow.
However, unlike the guaranteed income of a conventional annuity, income drawdown leaves investors exposed to market risk. It's worth noting that advisers also require additional qualifications when recommending this option.
- Variable annuities commonly referred to as 'third way' annuities; occupy the middle ground between conventional annuities and income drawdown. By offering both a guaranteed income and the potential opportunity to benefit from investment growth, variable annuities are seen to be a panacea by some but are still yet to be proven.
As certain providers step up their attempt to penetrate both the income drawdown and the conventional annuity market, through a variety of slightly different product propositions, advisers must decide if such a vast array of products is appropriate for their clients.
The complexity of variable annuities means they will not be suitable for everyone. With increasing longevity, is the assumption that people want to continue making financial decisions well into their retirement correct? Many people seeking advice just want to find the best annuity rate that will provide them with a simple and guaranteed regular income for the rest of their life.
Whether these products can enter the mainstream at-retirement market remains unknown. Additionally, the way that this part of the market is going to evolve is far from certain.
With simpler existing products that already offer the potential for investment growth, like income drawdown, unit-linked or with-profit annuities, advisers will have to be convinced that increased choice will really benefit their clients.
Making annuity advice pay
Some advisers, who offer a wide range of services but do not regularly write annuity business, may be apprehensive about approaching the at-retirement market. There is a perception that time spent on paperwork and administration is high, timescales to complete the transaction are long, and relative commissions are low.
For advisers looking to make annuity advice pay, there are other options available. In order to maximise business effectiveness, some advisers may benefit from referring these clients to a specialist annuity adviser in the same way that some are referring to other specialists such as for equity release. This allows them to offer a complete service to their clients, without needing to keep up with all the latest developments in the at-retirement market.
There are real opportunities for advisers looking to enter the retirement market. In 2008, the Association of British Insurers (ABI) estimated that two thirds of people now consider the Open Market Option when choosing their annuity.
Forecasts made prior to the launch of the FSA campaign to increase awareness of the Open Market Option, predict that the at-retirement market will grow to £18 billion a year by 2012. It's safe to conclude that these figures will rise as awareness increases.
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