How have recent regulatory changes and market movements affected the type of annuity products coming to the fore? Peter Davy finds out

Given their doubtful popularity it was fortuitous that the month annuities ceased to be a compulsory purchase they saw their highest rates for a year. According to MGM Advantage’s Annuity Index, conventional annuity rates entered April up 6.14 per cent on the beginning of 2011. It is, though, unlikely to be enough to save the market from significant change.

On the one hand the recent regulatory changes, including the scrapping of compulsory annuitisation at 75 and the recent European ruling on gender-based pricing, are likely to have only a limited impact. On the other, low interest rates, Solvency II and, as ever, rising longevity, mean the longer-term trend towards lower rates is likely to remain and, partly as a result, so too is the growth in the enhanced annuities market.

Earlier this year, Towers Watson put the value of enhanced and impaired annuity sales in the UK at £2.47 billion in 2010, an increase of 38 per cent on the previous year, and close to four times the size of the market five years before.

It has seen, as Tim Gosden, head of annuity product development at Legal and General puts it, “tremendous growth”, and it is likely to continue.

That's not just because of the regulatory nudges, but also because as the number of enhanced annuities increases, those failing to evaluate risks are increasingly going to be left with only the healthy lives. The result is that few would now bet against Gosden that the distinction between enhanced and conventional annuities will eventually break down entirely. Indeed, providers like Aviva have already merged their enhanced and conventional products.

It's not surprising, says Matt Trott, head of annuities at LV=. “After all, they're essentially the same product; they do exactly the same thing,” he points out. It's only the pricing that varies. If there's been a surprise, it's not that the product boundaries have blurred, but simply the way that's happened. “It was always assumed the big conventional providers would sooner or later move into the enhanced annuities market, but actually it's the enhanced annuities sellers that have moved towards the good health market.”

That should continue as specialist providers reduce the costs of access to the enhanced market. Enhanced annuity writer Partnership, for instance, recently launched a simplified process for accessing its product, allowing applicants to just answer yes or no to a handful of questions, rather than running through the entire common quotation form.

“Simplification is going to drive the product into the smaller fund values,” predicts the company's director of corporate partnerships Will Hale.

Too little too late
How much real difference that makes to retirees is debateable, however. At investment management firm AllianceBernstein, head of DC investment research and design for UK & Ireland David Hutchins points out that the trends towards individual pricing might make the annuities market more efficient, but will do little to address, what he argues, is the main problem: that most people probably shouldn't be buying them in the first place.

“More people might be getting the best price possible but it doesn't mean they're buying the right product,” he says, arguing that for many, drawdown is more appropriate.

The traditional argument against drawdown, of course, is that most pension pots are quite small – typically £20,000 to £30,000. At such levels, it has been argued that pensioners can't afford investment risk. Hutchins, though, denies that: 90 per cent of annuities sold, he points out, are level term, leaving them exposed to inflation.

“The assumption is that buying an annuity is safe, but you're actually taking huge risks.” The key selling point annuities offer is the guarantee of a payment for life, the real value of which comes in the latter half of retirement when drawing on the fund would have exhausted it. However, by that stage many will have had close to 20 years of retirement.

The real purchasing power of the annuity payment then could be tiny. Effectively defaulting members into annuities is a case of “reckless conservatism”, he says.

It’s a fair point, says Matt Ward, wealth manager at research provider Defaqto, who says there is considerable work to be done in getting workers to appreciate the different risks they face post retirement.

“It is not all about investment risk,” he says. “There's also risk in timing when you are buying an annuity and there's the risk of not shopping around, for example.”

Nevertheless, the attractions of drawdown remain limited. Defaqto's detailed review of the annuities market published in March noted that given the choice at retirement of a guaranteed regular income without the benefit of future investment growth or leaving the pension invested and taking income from it, respondents preferred the former, with 30 per cent opting for it against just two per cent for the latter. Likewise, the Pensions Policy Institute has estimated that 3.1 million at most are likely to use drawdown.

However, perhaps the most important finding of the Defaqto review was that an increasing number were willing to take at least some investment risk: 29 per cent were prepared to have up to 25 per cent of their retirement income dependent on investment performance and 15 per cent were willing to split the fund equally between guaranteed and speculative income.

“As people shop around more are concluding that a constant income at relatively lower levels is not always the most valuable prospect,” notes Ward.

More choice, more trouble
That leads inevitably to a consideration of third way products and offerings sitting between guaranteed annuities and the uncertainty of drawdown.

It's an expanding market (see box on page 44), where fixed term annuities, such as LV=’s launched last year and Aviva's offering to be released this year, compete alongside more traditional ‘with profits’ annuities such as Prudential's Income Choice. There is also probably better value than in the past, reckon advisors.

“There are some good products in this space,” says Billy Burrows, at William Burrows Associates, and more are likely to come.

How widely they're applicable, however, is still hotly debated. Just as with drawdown, some argue the majority will be excluded.

Burrows argues these products are really suitable for those with perhaps £100,000 to £250,000 in their pension pot. Much below that and they're still better off sticking with the certainty of a standard annuity; much above, and they'll probably take the advised route to drawdown.

It's the middle market that needs the help, he suggests. “It's typical middle Britain.”

That's not a view universally shared by providers, however. MGM Advantage, which launched its Flexible Income Annuity last year, for instance, is looking far wider. The minimum investment is £10,000, and its average case size is £60,000. “We set our stall out very clearly that this is a mass-market proposition,” says director Aston Goody.

Likewise, at Aviva while head of retirement Darren Dicks agrees that most investors in the fixed term annuities market are likely to be wealthier than average, each case is individual, and the market may be larger than some imagine.

“You can't just looked at the fund size; it's a bit more complicated than that,” he says. Other sources of income (such as DB schemes) and savings need to be taken into account, as does the risk appetite of the member.

“It’s not just for the very wealthy,” he insists.

Of course, such arguments point to an arguably greater barrier to uptake of such products: the need for advice and costs involved, which, as ever, remain key issues. It is, says Burrows, “the elephant in the room”. It is also one that trustees and sponsors are likely to continue to be wary of taking on for good reason; after all, it's a market IFAs struggle to understand. For now it is likely to limit the impact of the widening retirement choices in the occupational market, particularly since most still say annuities are good products for many if not most retirees.

However, steering clear of even advising workers about the existence of such options is unlikely to prove a long-term solution, and is not without risks itself. In the last month, for instance, claims management firm Brunel Franklin has turned attention from endowments to the potential for mis-selling claims in the annuities market and has announced it is piloting around 100 cases before it takes its findings to the Financial Ombudsman Service (FOS). The wider impact could be significant.

“That's probably what it will take to change things – a legal case to go through where someone has not been given proper guidance and someone is found to have been negligent," says one provider.

In the meantime, though, it can't hurt those running occupational schemes to start familiarising themselves with the options, because it's only going to get more complicated.

Peter Davy is a freelance journalist


An increasing range: product launches in the last year
LV=’s Protected Retirement Plan: a fixed term annuity written under unsecured pension rules so clients choose any level of income up to the maximum permitted by the Government Actuary Department (GAD). A minimum investment of £10,000 with terms between three and 20 years, maturing at age 75. Has a guaranteed maturity value and choice of death benefits including dependents’ income, guarantee period and value protection.

Canada Life's new personal product, the Guaranteed Retirement Plan: a single purchase guarantees a fixed amount of income deferred from between five and 20 years and paid to the planholder for the rest of their life. The minimum investment is £5,000.

MGM Advantage's investment backed annuity, the Flexible Income Annuity: Clients can choose a starting level of income and can vary the income level during the life of the product. The minimum investment is £10,000.
MetLife’s trustee investment plan, the Trustee Retirement Portfolio, with capital and income guarantee options: the product is available as an investment option for the trustees of SIPP and SSAS schemes.

AEGON's relaunched onshore investment bond with a secure income option: designed to provide the client with a guaranteed income of 5 per cent of their original investment over 20 years.

AXA Life Europe's Secure Advantage Protected Capital Plan and the Secure Advantage Lifetime Income Plan: designed to protect capital and guarantee a retirement income respectively. Available as a personal pension, a trustee investment plan and an offshore investment plan.

Aviva and Just Retirement are also planning to launch fixed term annuities this year; MetLife to launch next year.

Source: Defaqto's Review of Annuities and Third Way guide, available at: www.defaqto.com/adviser/ifa/guides

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