Fixed-term annuities have faced some criticism recently, Helen Morrissey asks whether it is justified
For the past six weeks the retirement industry has been vigorously debating fixed-term annuities and whether they are good products for today's retirees.
The discussion was kicked off by Legal & General's group executive director for protection and annuities John Pollock who was quoted as saying fixed-term annuities were not a good deal for customers and that the firm had voiced its concerns to the FSA.
The resulting furore saw providers and advisers alike voicing strong opinions both for and against the products. So what are the issues here and does Legal & Generals' view have any merit?
According to Pollock the uncertainties surrounding the effects of Solvency II and gender neutral pricing on annuity rates introduce increased risks to the annuitant.
He argues that retirees may not necessarily understand these risks and so may find they have reduced annuity purchasing power at the end of their guaranteed term.
"Clients going into a fixed-term annuity may benefit from a relatively short uplift now, but they need to understand the risks such as those attached with Solvency II and gender neutral pricing," he says.
"As yet we don't know what the implications of these things will be so how can the clients understand it too?
"There is such uncertainty in the market right now and that means I have big concerns. The industry needs to understand clients don't necessarily understand the macro economic situation like we do."
Intelligent Pensions technical director David Trenner agrees there are issues with fixed-term annuities.
The low rate of return generated can mean clients come out of the guaranteed period with less money than they started with and this coupled with decreasing annuity rates mean many annuitants would struggle to match the income they would have got if they had bought a standard level annuity.
"Five years ago annuity rates were around 20-30% higher than they are currently so even if you qualified for an enhanced annuity you may struggle to get the same level of income," Trenner says.
"If you didn't qualify for an enhanced annuity then what choices do you have? Do you have to go into another fixed-term annuity or purchase a lifetime one?"
While product innovation such as enabling the annuitant to exit the fixed-term contract in the event of divorce, marriage, early retirement due to ill health or qualification for flexible drawdown have improved the product they don't address the issue of poor rates of return.
As a result, Trenner believes income drawdown is often a better option for these clients.
"For instance if you had a £100k pot and wanted to take a £2.5k income then if I went into flexible drawdown I could take this level of income and invest the rest and get a better rate of return," he says.
"It is good to have these options but you can also get them under drawdown. I don't think fixed-term annuities are offering anything that you can't get in drawdown except perhaps for guarantees. However, there are products out there that do provide that such as MetLife's unit linked guarantees."
However, despite this, Trenner admits there are instances where a fixed-term annuity could prove to be the right result for a client.
"The area where fixed-term annuities have most application is when you have a client with £40k and doesn't need to take maximum income from it," he says.
"He is more concerned that if his circumstances change then his options remain flexible. Drawdown is too expensive for him and so fixed-term annuities could be an option."
The argument for...
Despite the criticism fixed-term annuities have faced it is also clear these products have many supporters. According to our latest research, 28% of participants saw fixed-term annuities as the main growth area in the annuity market and only 16% agreed with Legal & General's standpoint.
The Retirement Adviser's director Nick Flynn is one adviser who recommends fixed-term annuities. While he admits the market is facing its challenges, they remain good products for the right client.
"I think John Pollock's criticisms are fair but then in real terms there is always something on the horizon," Flynn says.
"Five years ago we could never have predicted that we would be in the situation we are in with the Euro for example so I think to say issues such as gender neutral pricing and Solvency II make the product unsuitable is extreme.
"While they are not a mass market product they form a part of the adviser's armoury to be used when necessary.
Flynn continues: "It is also fair to say that many of those who purchased these products six years ago may be getting a horrible shock right now as the income they can now purchase will have reduced.
"However, not everyone purchasing a fixed-term annuity will have done that. For instance, many have used them to access their tax-free cash but then have not taken an income from the fund."
Just Retirement's group external affairs and customer insight director Stephen Lowe believes there is strong customer need for fixed-term annuities and that advisers are adequately explaining the risks to them.
"I think the first question you need to ask is why people are choosing to use fixed-term annuities and there are several reasons for that," Lowe says.
"For instance, people may want to access their tax-free cash now but not start taking their income until later on. We undertook consumer and adviser research and we found there is a fairly equal split between those taking maximum income and those taking zero.
"There is no such thing as a typical fixed-term annuity customer as they all have very different needs and demand for flexibility. They want to maintain control without having to lock themselves into a permanent commitment to a certain income."
He continues: "Uncertainty around the income you can purchase at the end of the guaranteed period is the main risk associated with these products and advisers need to be explicit about how they discuss this with clients.
"Of course, we don't have a crystal ball and we don't know what the environment will be like in years to come, but at least engage the customer in these decisions and let them express a preference.
"When we have spoken to advisers about the product they know they have to explain the risk to people - every adviser I have spoken to is clear on this. Every product has some level of risk attached to it - are all of these risks explained?
"What about in the direct to consumer market? If an annuity is purchased here are the risks explained to that client?"
An adviser view
It is clear there are plenty of advisers recommending fixed-term annuities to their clients. Retirement Solutions managing director David Bell is one such adviser.
"If you have a client with no health issues then you need to be looking at offering them something more than a standard rate annuity," Bell says.
"If you aren't doing that then you aren't doing your job. The decision to recommend a fixed-term annuity is based on several ‘soft factors' such as divorce or re-marriage and to say these products are not a good addition to the market is not right. They are not a mass market solution but they do help certain clients."
The Retirement Adviser's Flynn agrees: "We don't use them frequently but we do consider them when they are relevant to the client," he says.
"It comes as a result of understanding the clients' objectives and finding the most suitable solution. If a fixed-term annuity is the right way to go then that is where we go. I would say they account for 5-10% of our business.
"There needs to be a reason to choose a fixed-term annuity. For instance do they have a good reason to suspect that their health may worsen during the fixed period? They may have been diagnosed with a condition for instance or have a family history of a certain condition.
"They could also be used to fill the gap between other retirement incomes kicking in. For instance, someone retires at 60 and their state pension and DB benefits kick in at 65 and they need a bridging income during that time."
It looks like the debate about fixed-term annuities looks set to go on for some time yet.
However, while it seems unlikely these products will be used as a mass market product it is clear that for certain clients they are the right solution.
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