Andrew Pennie looks at the implications of a client's health when providing ongoing retirement income planning and advice
There has been much publicity and coverage about the need to consider annuities for drawdown clients as they get older due to the increasing impact of mortality cross subsidy. However, little has been written on the importance of health and how changing health and lifestyle conditions can (or should!) drive changes to a drawdown strategy.
Enhanced annuities have been a growing development in the annuity market and we estimate that over 50% of retirees could now qualify for an enhanced annuity rate before age 75.
Being unaware of either the availability or scale of the enhancement available for an existing drawdown client breaches the ‘Know your customer' obligation and could render current advice unsuitable thereby potentially exposing advisers to future claims.
Clients who have spent many years playing down any medical condition they have in case of a loading for life assurance need to understand the importance of disclosing every condition, whether they consider that it is under control or not.
Completing a full medical questionnaire is essential for every client over 70 while for other clients you should ask three key questions at every annual review, which are:
• Do you smoke/drink?
• Do you take any prescribed medication?
• Have you spent any time in hospital recently?
Most advisers are aware of the availability of ‘smoker' rates, but few are aware that there are some 1500 conditions which will qualify for some sort of enhancement. Generally speaking the number of prescribed medications gives a very good guide to the detailed medical condition.
We consider ages 70-80 to represent the ‘decade of annuitisation' (phased annuitisation!!) for the majority of clients in good health. However, where a client qualifies for an enhancement, annuitisation should be considered based on their deemed annuity age and brought forward accordingly.
It is important to consider the differences between chronic and acute conditions, and the effect they have on annuity rates. Clients with chronic health conditions such as diabetes will qualify for an enhanced annuity but this does not necessarily mean that the client should buy one today. Because their condition is incurable they will always qualify for an enhanced rate.
However if a client suffers an acute health condition (e.g. heart attack and some forms of cancer) they will generally qualify for a significant enhancement shortly after the incident.
Thereafter, the rate of enhancement will start to recede, sometimes to the point of no enhancement whatsoever. Clients who have had an acute condition can be very focused on ‘beating the illness' and this can create opportunities to drive a client's retirement strategy:
• You could advise the client to invest a proportion of their fund into an annuity taking advantage of the high immediate enhancement to complement their long-term strategy of beating the illness and taking advantage of the higher income available.
• Furthermore, a well diversified drawdown portfolio will contain a proportion of low risk bonds/gilts. These assets are currently expensive and generating low rates of return.
A high enhanced annuity could be used to replace some of these assets at favourable rates which could allow a client to draw more income now, or increase equity exposure in the remaining fund to aim for higher growth and higher future income.
Just as we would not recommend a client switches 100% of his fund into (or out of) equities on any one day, it is essential to understand that there is also no one day when a fund should be sold and an annuity purchased.
Market timing risks make this approach unsuitable and, as conventional annuities are an effective ‘one way street' for the purchaser, the risk of choosing the wrong basis could cost dearly.
Phased annuitisation, combining conventional and asset backed annuities as befits each stage of the exit strategy, can be a highly effective approach to deliver ongoing flexibility and investment participation, while progressively securing the long term income for the client and potentially taking advantage of attractive enhanced annuity rates.
The regulators are looking for advisers to demonstrate ongoing suitability of drawdown and this requires a detailed annual review where the adviser elicits accurate and relevant information to be able to benchmark drawdown against the alternative options available to that client.
If a client qualifies for an enhanced annuity they should be made aware of the fact and it should be factored into advice/reporting as well as ongoing suitability justification.
Client complaints are often driven by wonderful hindsight and it doesn't take much to think of a client who claims they would have bought an enhanced annuity last year had they known it was available following a fall in value of their drawdown fund.
A robust review process is therefore essential and can be delivered in-house or in collaboration with a retirement specialist to help deliver quality client outcomes and manage the potential risk to your business.
Andrew Pennie is marketing director at Intelligent Pensions
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