Kim Lerche-Thomsen takes a look at how annuities can meet people's changing retirement needs
What are the main difficulties people have with annuities?
Lifetime annuities were fine when people reaching retirement only had an average of perhaps 10 years to survive on the income. These days, life expectancy for a 65-year-old is more than 20 years and one-in-ten is likely to reach the age of 100. This raises two main problems. The first is that the increase in longevity has pushed down the income available to such an extent that they offer a poor deal, especially in the early retirement years. The second is that they are inflexible: a retiree will go through different stages during their retirement with different income needs, but buying a lifetime annuity effectively hands over all control to the insurer and removes any ability for people to rethink their finances.
Do you think people are being forced into making irrevocable retirement planning decisions too early?
Most people, up until recently, have had little other choice but to opt for a lifetime annuity at retirement. Income drawdown is simply too expensive and too risky for all except a wealthy minority. I can't think of another product that, once bought, you are locked into for the rest of your life. Male single-life annuity rates for a purchase price of £100,000 would pay about £5,200 a year to a 50-year-old. Assuming fixed interest investment returns of around 5% and this person is gaining just £200 a year for putting £100,000 at risk which is a very poor deal. For a 75-year-old the annual income would be boosted by mortality sharing to £10,000, equal to a £5,000 extra return for putting the £100,000 at risk, a much better proposition. I believe many people would benefit from delaying buying a lifetime annuity until aged 75 and ideally I would like to see the age limit raised to 80. The other factor is linked to how people's lives change in retirement - a 65-year old is likely to be quite healthy but by the time they reach 75 is far more likely to have been diagnosed with a serious illness and could gain greater income by opting for an impaired life annuity.
How can annuities be made more innovative?
At present people choose either the secure income but restrictions of a lifetime annuity, or they choose the risky, costly income drawdown option. Logic would suggest the mainstream market would lie somewhere in the middle of these two extremes. Living Time's current products mirror the low cost, transparency and secure income of an annuity during the term but then pay out a guaranteed maturity amount. This gives people the flexibility to rethink their options at a later date. We have seen other entrants, mainly from the US, but most of their products carry a very different product profile. They have significant investment risks and higher charges, operating more like income drawdown products than more flexible annuities.
How can the quality of advice given to clients be improved?
The government could help by removing some of the constraints on the current rules. For example, the rules still insist that buyers of our products have a five-yearly check-up, despite the fact that both the income and maturity amount is guaranteed at the outset. It is interesting to note that pension simplification last year tried to create a single set of rules for pension accumulation, but those reaching retirement still face the complexities of two polarised options. I strongly believe that if people only take financial advice once in their lives, retirement is the time to do it. The Open Market Option (OMO) is one obvious area which could deliver better value but there has been no significant change in take up. At present it seems the majority of people who buy an annuity are never told that there is an alternative. Many of these buyers probably do not understand annuities let alone the alternatives but these are precisely the people who need to make more informed decisions. I have a real sense that a few years down the line many will look back and wonder why they are locked in to a lifetime annuity.
How can you see annuities developing in the coming years?
The retirement market is ripe for sweeping changes that will bring the income options back in line with people's needs. One development we are already noting is that people are seeing their pension as only one of their income options. An example of this would be, instead of choosing equity release, taking a higher income from retirement savings in the early years. The retirement pot would run down more quickly, but people would gain overall because interest would not be rolling up on the equity release loan. People then have the flexibility to decide later to use equity release, but for a shorter period of time and with any advantage from further rises in property prices. Another area ready for innovation is for care fees. I would like to see the government allow some pension money to be set aside at retirement to help fund future care home fees.
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