Just over two years ago, the pension world was rocked by the announcement that people would no longer need to buy an annuity. It was a matter of seconds after the Chancellor had finished delivering his March 2014 Budget when the first of many customers called our offices to cancel their application for an annuity.
What happened in the days and weeks after that announcement were headlines and suggestions that the annuity market was dead and that sales would plummet, which of course, they did. But die, they did not.
The latest fact sheet from the ABI statistics suggests that individuals who have retired in the last year, have, on the whole, adopted a sensible and cautious approach.
Yes, around £3 billion has been withdrawn as cash from pensions but when one considers that the average pot size was around £15,000, you would be hard pressed to think of any alternative that would have as direct an impact on lifestyle as a full withdrawal. The fact that in the last quarter of 2015 over half of all cash lump sums were for individuals under 60 suggests we may be seeing a shift in how people retire.
Recent Canada Life research suggests that over 60% of individuals do not expect to stop working completely when they ‘retire’ and we are seeing trends where people are choosing reduced hours contracts rather than a hard stop. Just last month the former Director General of the CBI John Cridland was appointed to lead the first re-assessment of the pension age. He is charged with considering life expectancy and ‘wider changes in society’. The news was greeted by headlines suggesting that tomorrow’s generation will need to work until they are 75.
What does appear clear though is that flexibility and security remain at the heart of retirement for most individuals.
As expected billions that would normally have gone into an annuity have poured into drawdown contracts and for many individuals this would have been the right thing to do. However, since pension freedoms those individuals have witnessed the FTSE 100 fall by over 10%.
One of the challenges for customers is ensuring they understand sequencing risk when considering a drawdown. After all, performance can be shown in a number of ways from compound growth, to discrete year on year performance to annualised returns. Less experienced individuals view annualised returns as the simplest way of picking a fund (despite the warnings that past performance is no guarantee of the future). So obtaining financial advice is something we believe is essential to ensure an individual understands the risks they could be exposed to.
The recent volatility experienced across equity markets in particular has made individuals approaching retirement think about what is most important to them. Individuals who chose to withdraw an income of around 5% last year may have seen their pension funds drop by closer to 16% because of their timing.
During focus groups with consumers approaching retirement or at retirement last year, we asked what was most important, growth potential or surety of income. Whilst growth is still important, the overwhelming consensus was that by retirement age ‘if you haven’t made it, you’ve got to make sure you keep what you have built up’.
This somewhat explains why we saw annuity sales plateau in the latter half of 2015 and more advisers are now looking at ways to provide security of income allied to investment strategies that can give growth potential. Blended solutions offer advisers the opportunity to truly customise solutions for their clients and add real value to their own service propositions. It is also fair to say that offering an annuity as part of a broader retirement solution is a lower cost way of providing the guaranteed income that most individuals look for.
Let’s not forget that some of the concerns of individuals about annuities were removed in the Pension Freedoms legislation. For example, individuals can now guarantee their income for longer than 10 years, in some cases up to 30 years, which can not only guarantee full payback of capital but often more, making them a more appealing proposition than they were a few years ago. In fact our own experience has shown more than 12% of guarantees taken are for terms longer than 10 years with a fair proportion at 20 years and 30 years.
The ABI data highlights that the Annuity market is not dead, but it has changed. Instead of the default option for most individuals it now occupies a legitimate place in the bank of solutions available to those looking for a retirement income. We expect that as more advisers look to broaden their range of solutions, annuities will continue to have a place in the retirement income planning process. Whilst we believe this could still be the right solution for some individuals, especially those who are risk averse and want the certainty of a guaranteed lifetime income, and with many alternatives for shorter term objectives now entering the market, lifetime annuities could become a more relevant product for later life.
Alternatives enter the market
There are alternative products that have been introduced over the last year. Fixed Term products are seeing traction among consumers who want a guaranteed income without the need to be tied in for life. Canada Life has seen significant volumes of individuals choose this option with a range of terms from 1 year to 20 years. At the end of the chosen term, the individual receives their guaranteed maturity value which they can reinvest, withdraw or use to purchase an alternative retirement income product.
These products allow advisers to bespoke retirement solutions for their clients in a way that was not possible for the majority of individuals prior to pension freedoms. Choosing a Fixed Term product can allow an adviser to meet a client’s immediate income needs in a secure way which then allows them the flexibility to concentrate on continuing to build for longer term growth and income in later retirement life.
This type of solution allows advisers to offer flexibility and security for clients and represents an excellent way for advisers to regularly engage with their clients to continually provide the on-going retirement solutions that today’s market will seek.
In summary, a year on, Pension Freedoms has had significant impact in terms of behaviour of individuals approaching retirement and in terms of the products that providers are continuously developing. For advisers, it has created an opportunity to redefine their service propositions and business models. We believe that there will be more enhancements and changes to come.