December 2007

GAD damn it!

Third way products have been viewed with interest by the pensions industry and advisers since they first appeared in the UK just over a year ago. Many cite these products' ability to provide a guaranteed income for life alongside the chance to gain from market performance as an ideal way for many people to take their retirement income. However, these products have not been without criticism. Advisers have labelled these products as complex and expensive - major barriers to the future growth of these products in the UK.

One of the issues causing complication was the use of Government Actuary Department (GAD) limits in third way products. GAD limits are used in drawdown products and are designed to prevent people from taking too much money from their funds by imposing maximum limits on the income to be taken. These limits are subject to review every five years. It's easy to see why these limits have an important part to play for someone in drawdown as they are exposed to the vagaries of the market. However, to what extent should they apply to third way products which often already guarantee an income for life?

"When you have a product where the funds are guaranteed and so have no investment risk then the need to have these GAD limits and reviews disappears," says Kim Lerche-Thomsen, CEO and founder of Living Time. "With fixed term annuities like ours as long as you start the income off correctly then you don't need reviews - they are an unnecessary complication. It does nothing for the customer and just causes extra administration."

Mark Hills, product development manager at Lincoln Retirement Income agrees saying the use of GAD limits can cause extra complications in product design.

"The purpose of the GAD limits is logical and there are good reasons why they are used but most third way products already have an income guarantee so it does cause complications. During our product design we had to be careful that we didn't end up specifying a minimum income that actually exceeded that person's maximum GAD limit," he says. "It's unnecessary from a customer standpoint. The purpose of the maximum is to ensure the customer has an income for life but if you already have a guaranteed minimum income for life then that achieves the need. It's a case of legislation not keeping up with innovation."

Pre Budget Report

Up until October there was hope that the government might address this issue in its Pre Budget Report. However, this hope was dashed when the Chancellor decided against amending the tax rules around GAD limits saying that to do so would add an extra level of complexity that would only benefit few people. Needless to say third way product providers were disappointed.

"Applying GAD limits makes third way products more complicated than they need to be," says Mark Stopard, director, pension products at The Hartford. "By doing this it means product designs are more sophisticated and are aimed further up the market and so miss a big part of the market where they could add a lot of value to retirees. If the rules were simpler then we could put simpler products out there which could service those further down the income spectrum."

Not only was the announcement disappointing in not allowing a simplification in third way product design it also appeared to show something of a disconnect between the government view of third way products and that of the providers. The government response seems to signify that third way products are niche, a far cry from the thoughts of many third way product providers who believe they have the potential to become a mainstream way of taking income.

"The view that has emerged in my interpretation is that the government thinks the rules are sufficient and retirees have a nice choice between lifetime annuities and drawdown," says Lerche-Thomsen. "However, I think they are missing the point as these products are both extreme endpoints and you should have a middle market between the two. They still seem to presume that people will eventually get a lifetime annuity and that shouldn't be the natural starting point. The lifetime annuity is unique in that it is a product that you can't get out of and that seems fundamentally wrong to us."

Hills agrees saying that; "What we wanted would have added complexity to the legislation but would have simplified things for the customer. Maybe the government is thinking too much about the legislation rather than looking at it from the customer's perspective."

The need for innovation

It is clear that it will only be through continued close work with the government that the industry will see any change to the legislation. So where does this leave the third way product model right now? Will it be consigned to serving the upper realms of the market for the time being rather than developing mass market appeal? According to Peter Carter, head of technical services at Met Life the only way forward is to work within the rules to deliver innovative solutions.

"It's incumbent on providers to show the way and be innovative by coming up with solutions that meet client expectations," he says. "You might not be able to do exactly what you want to do but you can still be innovative within the regulations. You can't make the assumption that legislation is there to constrain you. We talk to government on a regular basis to make sure our thinking is in line with theirs so we can meet their policy objectives. We talk on a regular basis and try to understand where they are coming from. We don't always agree but we try to understand them and they try to understand us and I think that's a good way to maintain a reasonable relationship."

It would seem then that more work needs to be done to heighten awareness of the third way product concept but that in time things will change and they will gain more widespread acceptance both by Government and the population as a whole.

Peter Magliocco, associate regional director at The Annuity Bureau is positive about the future for these products.

"There does appear to be a time lag between the products being developed and whether they are being accepted and discussed," he says. "However, it's a bit like a snowball - it takes a while to get going but then once it does it really starts to build momentum. If you look at the US these products account for something like 68% of the market so if we take a lead from the US then they will become more mainstream."

Will Hale, head of distribution at Lincoln Retirement Income agrees saying that providers need to focus on raising awareness if further progress is to be made.

"There is an education exercise that needs to be gone through," he says. "We need to focus on customer needs and how these products address those needs. To do this providers need to take the lead and connect with the Government, FSA and industry bodies to demonstrate what we are trying to achieve."

Helen Morrissey
Editor - Retirement Planner
Incisive Media