Steve Lowe discusses recent evolution within the annuity market
The concept of annuities dates back to Roman times but could see as much development in the next few years as they have in the previous two millennia.
There are some fundamental factors driving dramatic changes in the retirement income market, the primary market for lifetime annuity sales in the UK. This is opening up new opportunities for financial advisers able to show they can add value to the annuity buying process.
The first major factor is market growth, in large part due to the ‘baby boom' generation reaching retirement age. Next year the number of people reaching their 65th birthday will spike to above 800,000 for the first time. The numbers then drop back before inexorably rising again, a sign of Britain's rapidly ageing population.
An increasing number of these retirees will have built up defined contribution pensions and will need to make a choice about how best to switch on income from their funds. While the wealthy may look to alternatives, the vast majority will still be best served by looking for annuity-style products that remove investment risk.
The retirement income market is forecast to grow from around £14bn today to around £23bn within three years. That is a market opportunity we think is too big for professional advisers to ignore, particularly where retirees need to deal with the effects of spreading out their income over longer lives.
There are some important regulatory and legislative drivers that are set to have an impact too. The current review of the open market option holds out a promise that retirees will be encouraged to shop around to find better value. There is also implementation of the Retail Distribution Review (RDR) that will force some IFAs to be more accountable to clients in the value they add and the fees they extract when giving advice.
There are also changes such as the EU's gender directive which will stop insurers from using gender to price insurance products. The latter impacts on annuity sales due to the fact women receive less annuity income per pound of pension fund due to longer average lives than men.
Two important final factors are competition and technology. The billions at stake are already spawning new distribution channels, often driven by the low cost efficiencies brought by technological leaps.
One major effect of all these changes will be to accelerate the move towards personalised underwriting of annuities. This is not only good news for clients but for advisers too, because it is a golden opportunity to add value to the service given to clients without adding major costs.
In many ways, annuity pricing is in its infancy compared to what the future holds. Recent years have seen the launch of enhanced and impaired annuities, plus pricing on lifestyle factors such as smoking and where people live. Today's ‘broad brush' categories are being developed and refined as our insight and ability to use that knowledge grows we are becoming more able to price not just on single factors, but on combinations of factors with the eventual goal of a personalised annuity rate for each individual. Today we rate using over 1,500 factors.
The more detail we have about clients, the more accurate and the fairer the annuity can be priced. However, many advisers may question whether it is cost effective for them to go into such detail, particularly when many of the pension pots they are asked to deal with are modest.
The method by which information is gathered is the second major area of change. As the detail required gets more complex, particularly around medical history, it makes sense for providers to shoulder some of the burden. We are piloting both online and tele-interviewing services, using medically trained staff, that deal with the client directly and take away any discomfort for an IFA asking advanced medical questions.
This active participation is resulting in more clients receiving offers of enhanced rates. The pilot we have been running shows up to 70% of annuity buyers could qualify for some kind of enhanced rate. That is quadruple the current number who currently secure enhancements and a measure of the massive numbers missing out on extra income.
Personalised underwriting is a way for advisers to differentiate their services from the competition, particularly from basic online annuity portals that are starting to spring up and from simplified advice services post-RDR. There is no doubt that a plethora of ‘cheap and cheerful' distribution models will spring up with one-dimensional offerings. It will be as difficult for IFAs to compete on unit costs with these as it is for small shops to compete with supermarkets and online retailers. From the fact find onwards, enhanced annuities represent a good opportunity to demonstrate a value proposition in the new fee-charging world. Forward-thinking providers are already developing the tools and services advisers will need going forward.
Let's not forget the clients. Our experience tells us that at such an important time of life, they actively appreciate a more comprehensive examination of their circumstances and options. Above all, they want to be dealt with as individuals and professional advice combined with personalised underwriting gets closest to that ideal.
Steve Lowe is director of external affairs and customer insight at Just Retirement
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