Response from Tim Gosden, Head of Strategy for Legal & Generalâ€™s individual annuity business on Steve Webbâ€™s idea for annuity switching viable.
08 January 2014
How flexible is the current system?
The UK system of retirement income provision is the most advanced in Europe and probably leads the world. Consumers have the freedom to shop around the market for the best income solution and obtain financial advice if they wish. There are a multitude of diverse product options including conventional guaranteed annuities, which are both standard and enhanced, investment linked annuities, flexible annuities, fixed term annuities, variable annuities and income drawdown.
Is switching viable for the mass market?
The conventional annuity is the core product in the marketplace and according to most recent industry statistics accounts for roughly 90% of all retirement income contracts sold. This is simply because most consumers desire a guaranteed income stream.
Conventional annuities are often criticised for being inflexible because once taken out they cannot be altered to take account of changing personal circumstances and/or market conditions. However, when purchasing an annuity the most important considerations for consumers are health issues, which could lead to improved terms, the provision of death benefits for a spouse or partner and shopping around for the best deal.
Given the average UK pension pot is currently around £32,000, the reality for most consumers is that their private pension is often just a top up to the State scheme and so the flexibility to be able to change their annuity may come at a cost that most would simply not consider. Also, without the services of an adviser it is likely many wouldn’t use the option or know when to use it.
From an annuity provider perspective, to facilitate a switching option as suggested by the minister would be challenging. Such a feature would introduce a liquidity premium which means providers having to reserve more and so potentially having to reduce the rates offered. We estimate that the impact could see rates as much as 25% lower than the conventional rates available today.
To offer the more competitive rates available today most providers invest in illiquid investment opportunities, such as infrastructure projects, that cannot be readily traded, but which offer better long-term returns.
Is there a demand for the existing more flexible solutions?
Fixed Term annuity products were specifically introduced to counter the flexibility criticisms of conventional annuities. With these products a short-term annuity is purchased with some of the fund, while a guaranteed maturity value at the end of the term is provided with the rest of the fund. So at a future date a new retirement income product can be purchased, maybe on better terms if circumstances, such as a deterioration in health, has changed. While these products are innovative and to an extend address the flexibility criticism, they currently account for less than 1% of retirement income contracts sold. This is mainly because they can only be accessed through financial advisers who will usually recommend them to customers with larger pension funds.
Does the current system cater for everyone?
Flexibility and choice already exists in the UK annuity and income drawdown markets. There are already alternatives to the conventional annuity for those that require flexibility and who are willing to take more risk. The question is how consumers can access these products particularly if they do not wish to use the services of a financial adviser.
The conventional annuity product fulfils a hugely important need and so perhaps the solution is more about improving accessibility to these diverse alternatives, but only to those for who they are suitable.
What’s the best thing consumers can do?
Get advice and shop around. There are competitive annuity providers that offer a good deal and value for money.
Talk to someone! Not everyone will opt for the services of an adviser but we believe everyone deserves a conversation about their annuity with someone knowledgeable. Annuity purchase is perceived as a complex decision and many consumers find they are confused and often take the easiest route, which may not be the best one for them.
The industry needs to find a way of ensuring that every consumer has that conversation, whether that is with their provider or with an adviser or an intermediary.
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