Andy Zanelli and Simon Smallcombe go through the key issues to understand about third way products
It's now over five years since ‘third way' or ‘variable annuity' solutions were introduced into the UK market. However, there are still many misconceptions as to what these solutions are, the key benefits offered, and how they can be used or blended with the more common retirement solutions for greater client benefit.
1. What do the terms ‘third way' and ‘variable annuity' mean?
Labels like ‘third way' and ‘variable annuity' don't yet quite make sense in the UK. Variable annuity is a term imported from America which doesn't really mean the same thing here in the UK. There are many products on the market that get categorised as variable annuities which aren't annuities at all. The ‘third way' phrase was adopted at the outset of the launch of these solutions as a differentiator between annuities and income drawdown, but again it only covers one aspect of planning at retirement, whereas there are many other types of solution.
2. How would you describe them?
At a very basic level, they are unit-linked contracts with guarantees, so advisers should not be put off by the terminology. These solutions use the same tax wrappers that advisers have been using for years, with virtually the same tax treatment. They simply have some interesting additional features, such as guarantees, which mean they can be used to overcome current day challenges which advisers and clients face.
3. What tax wrappers are available?
They are generally available as personal pensions, for use pre- and post-retirement, as trustee investment plans for use within self-invested personal pensions and small self-administered schemes, and as offshore bonds.
4. What types of guarantees are available?
In the UK market there are generally solutions available offering capital guarantees or income guarantees, usually with the option of adding a guarantee on death during the term.
5. Why are these types of solution favourable in the current economic climate?
We live in a world where market volatility is increasing, people are living much longer and inflation is raging. With this range of client issues, providers and advisers need more varied solutions to attempt to deal with these challenges.
6. So if there is nothing new in terms of the tax wrappers being used, how do these solutions address the challenges highlighted?
The key is in the various guarantees that are available and using the appropriate options for the right clients. Many of these solutions are standard unit-linked pension or investment contracts, which means of course that the value of the plan can go up and down with the markets. However guarantees are available that will ensure a certain amount of capital is available at a future date or a certain amount of income is always available to the client.
7. Is it true to say that these solutions have unique features allowing clients to benefit from the good years in the market, while protecting them from the bad years?
There are options available for locking in growth at various time intervals - for example a lock-in could occur every year. Clients are unlikely to retire at an exact high point in the markets so having features which lock in their growth and allow them to take income based on the highest point reached on previous anniversaries, can be a great way of ensuring clients get invested, stay invested and ride out market volatility.
8. Can these types of solution blend in with my existing advisory business model?
Many advisory businesses are building defined investment propositions, keeping the client's attitude to investment risk at the forefront of this work. The Financial Services Authority has highlighted an insufficient focus on attitude to risk as a key issue and made it a centre piece of the Retail Distribution Review. It's also now clear that an adviser must review a client's capacity or tolerance for loss too. i.e. how much capital can they lose before it will affect their standard of living in retirement?
Many unit-linked contracts that apply guarantees will offer risk-rated portfolios as the underlying investments and advisory businesses should examine these carefully and ensure that they are consistent with any wider processes within the business. Such guaranteed contracts often have a limited investment range, in order to be able to apply the guarantee successfully, but this doesn't mean they can't automatically fit within a wider proposition. If the risk rating is clear and a common understanding by both adviser and client can be demonstrated, then the building blocks are in place.
9. Do I need to research this market thoroughly?
Yes, the FSA covers these types of solution in their consumer documents on income drawdown, so the most important thing to stress for advisers is that they need to understand the way in which any guarantee works. Does it apply to capital or income? How often might a lock-in apply? What is the underlying surrender or transfer value? And then choose the right guarantee for the right client. Used correctly these are very powerful tools for solving client problems and overcoming the challenges facing today's retirees.
10. Can I blend these solutions into my existing client offering?
Many advisory firms are trying to create processes to ensure continuity of advice throughout their business. Firms which have already embedded the ability to identify such solutions as being suitable for their clients into their fact-finding process, are able to consider all the options available to the client, discussing the merits of each in turn, to make an informed decision.
It is worth considering if your processes take into account the functionality available from these new developments in the market, as many firms are finding that their existing processes may need to be reviewed to ensure that all new developments are considered when building the right solution for the client at retirement. This could include third way products, flexible drawdown, re-considering phased retirement and so on.
Andy Zanelli is head of technical sales, AXA Wealth and Simon Smallcombe is head of variable annuity sales - UK, AXA Global Distributors
‘Important to have an anchor’
Report to be written by TPR
Lack of innovation for solutions
Some 2,000 consumers affected