Enhanced annuities have gained popularity in the last few years, but will the RDR have an adverse effect? Sally Ling reports
Take-up of enhanced annuities has been increasing rapidly in recent years. But, as the retail distribution review (RDR) has changed the charging structure for advice, moving firms away from commission to a fee basis, has this in turn affected the number of people being advised to obtain an enhanced annuity?
With the trend in workplace pension provision moving away from defined benefit (DB) to defined contribution (DC) there has been an increasing focus on making sure members get the best deal at retirement. The government, the Financial Conduct Authority and the Association of British Insurers (ABI) have all been active in trying to change the behaviour of both providers and consumers. One outcome of more people shopping around has been an increase in sales of ‘enhanced’ annuities – also known as impaired life or individually underwritten annuities. These differ from standard annuities in that they take account of health and lifestyle factors as well as age at retirement and this can lead to an improved level of income.
Research suggests that between 60 and 65 per cent of people could qualify for some form of enhanced annuity. While take-up is still well below this level, it has been increasing rapidly. Just Retirement director of external affairs Stephen Lowe observes that the enhanced market has grown in value by 30 per cent pa compound since 2008, while the annuity market as a whole has seen single-digit increases over the same period. In 2012 enhanced annuities accounted for 32 per cent of single premium annuity purchases by value - £4.5 billion out of a total of £14 billion. In terms of numbers of policies, 21 per cent of annuities sold include some form of enhancement. According to Lowe, an estimated 50 to 60 per cent of people buy their annuity from their provider; of these just 5 per cent get an enhancement.
What does RDR mean?
The RDR, which came into effect in January this year, outlawed the charging of commission for financial advice. Instead, such advice can only be provided on a fee basis. The aim is to improve transparency, allowing clients to see how much advice is costing them and, in turn, understand what benefit they derive from it.
So, is the prospect of paying a fee putting people off taking advice on enhanced annuities? It should not do as, according to RSM Tenon managing director John White, in most cases the cost has gone down. He says that fees now equate to around 1 to 2.5 per cent of fund value (dependent on if advice is given), whereas commission could be as much as 3 per cent; the client just didn’t see it.
White says: “The statistics show that there has been a fundamental change in advisers’ earnings and the number of annuities sold post-RDR. There was a spike in annuity sales in the run-up to RDR but this could have been influenced by a number of issues including the abolition of gender-based annuities. Another reason for the drop in annuity sales in the first months of this year was that advisers were focusing on retraining to provide advice in a post-RDR fee world so there was a loss of momentum.”
The recent improvement in stock market performance has also suppressed annuity sales. As White says: “Actions don’t always follow advice. While you might expect someone taking income drawdown to see an increase in their fund value as a good opportunity to buy an annuity, many take comfort from it and simply carry on with drawdown. This has probably had a bigger effect on annuity sales than RDR.”
Is advice necessary for enhancement?
There has always been a cost involved in buying an annuity but there is concern that, now the cost of advice is transparent, people will be put off by the sums involved. This could mean that fewer people become aware of enhanced annuities. But this does not mean that people face a stark choice between paying for advice and having to settle for a standard annuity. Enhanced annuities can also be bought on a ‘non-advised’ basis whereby the broker or financial adviser searches the market and provides details of suitable products. But, rather than receiving a recommendation, the final choice is up to the buyer. This approach will take account of health and lifestyle factors, but the buyer will not be advised on other features such as escalation and survivors’ benefit. Such sales are often transacted on a commission basis.
As Lowe explains, non-advised does not mean unassisted. Where a sale is conducted over the phone, customers will have the features of the annuity explained to them by a skilled person and will be able to ask questions. This process can give people the confidence to make a choice from the range of annuities presented to them.
The non-advised model is also used by the increasing number of online annuity portals, which allow people to search the market for the ‘best’ deal. Many of these include enhanced annuity specialists in their provider panel, but Jelf Employee Benefits head of Jelf Money after Work Lee Coles warns that they do not necessarily ask the right questions to get the highest possible take up of enhanced annuities. He adds that people might be cautious about disclosing detailed personal information online, saying: “If you are giving information over the phone or completing a form and posting it, you know where the information is going and this gives confidence the information won’t be intercepted. This might be a generational thing though, which changes over time.”
In March this year a new ABI code on retirement choices came into force, requiring pension providers to ask certain mandatory lifestyle questions and to provide personalised annuity quotations. Providers which do not offer enhanced terms must make this clear and state that people might achieve a higher income by shopping around. Lowe says he has already seen a change in behaviour since the code came into force; some providers have gone into partnership with enhanced annuity specialists while others have outsourced their annuity function completely.
London & Colonial product and business development manager Adam Wrench feels that while the ABI code is a step in the right direction it does not go far enough in making sure individuals understand all the available options. He says that currently, if an individual is able to access the ‘locked in’ annuity that offers the highest rate at retirement – whether standard or enhanced - this is considered a satisfactory exercising of the open market option. This, says Wrench, is far from being a whole-of-market approach, as it does not cover alternatives such as income drawdown or fixed-term annuities, nor indeed L&C’s reviewable annuity, which allows people to access better rates as their health declines with age.
Advice in the workplace
The ABI code only applies to contract-based schemes – members of trust-based DC schemes do not have the same protections. Coles says that with workplace schemes the question is how people become aware of the availability of enhanced annuities. He observes that most employers are reluctant to pay for financial advice except perhaps for their executives. They are more likely to be prepared to pay a fee for financial education. As a result trust-based schemes generally go down the non-advised route. White confirms this view, saying that employers have never been good at the ‘at retirement’ piece - very few offer any sort of retirement counselling. He suggests though that while employers could do a lot more, it is also down to the advisers to offer more to older workforces.
So, what is currently preventing more people from benefiting from enhanced annuity rates? Lack of awareness and poor understanding of how to access them are two factors which should not be too hard to address with better financial education. People can also be reticent about talking about their health, making light of any problems in the fear that it could have an adverse effect, on their job prospects or their insurance for example. As White points out: “It is the opposite with enhanced annuities, we need to know everything to ensure the best rates for our clients.” Again this can be overcome with better awareness.
The expectation is that the take-up of enhanced annuities will continue to increase. As Lowe points out, policies in other insurance markets are individually underwritten so there is no reason why this should not become the norm for annuities.
Written by Sally Ling, a freelance journalist