July 2008

Here to meet needs

The baby boomer generation is one with attitude. Forty years ago the student riots across Europe - especially France - made sure this generation acquired the reputation for being rebellious and having anti-establishment views. Since then they have strived for control and innovation in all areas of their lives. Now as they approach retirement - both wealthier and healthier than previous generations - they see no reason to compromise.

It was obvious the pension retirement market would change to accommodate this generation by offering new choices and flexibility, and, above all, control.

The options of annuities and income drawdown go a long way in matching people's needs in retirement. However, these products are very different beasts and suit different clients depending on whether they want no risk or more flexibility.

Over the past few years, it has become increasingly apparent that those who want to retain flexibility over options such as death benefits were forced into income drawdown, even if they wanted a guaranteed income.

The new middle market retirement income solutions - called variable annuities or living benefits - have evolved to fit this need. This is drawdown with a guarantee that the income will remain at least at the same level for the person's life. They give people longevity insurance without having to go along the one-way route that is buying an annuity.

So, they offer something that wasn't there before. This is an insurance product offered by insurance companies. The client is paying an insurance premium for a guaranteed income. The question is whether the extra cost is worth it?

The worth of insurance, of course, can easily be measured if you make a claim. So, for example, if you insure your house against fire, you will think the money is well spent if your house burns down. By the same token if the market drops at the same time someone's quinquennial review is due on their income drawdown plan, the GAD rate tumbles giving a much lower income. If there is an insured guaranteed income that kicks in, then the insurance premium paid to secure that income might be seen to be worth it.

However, insurance isn't just about getting a return for premiums paid; it's also about buying peace of mind. It is about protecting against the worst possible outcomes, which you either don't want to live with or can't afford to live with. This is where it gets a little more complicated, because many people prefer to be risk-free, and they are willing to pay premiums to get that all important peace of mind.

Peace of mind is a hard thing to put a price on. It's a personal thing.

Some people are happy to live with the risk, and are happy to forgo the insurance on drawdown; confident they have assessed the outcomes, and can live with the consequences.

However, some aren't. They would prefer the certainty of knowing that the income they bought is theirs for life. They want the control, but also the flexibility keeping control over their investment brings.

Middle market solutions are not a panacea. They will not be right for everyone, but they will be right for some people. They don't necessarily have to offer all the answers, they could form part of an overall retirement plan together with income drawdown and/or annuities.

However, the point is they are here, evolved to meet people's behavioural needs, and will be the right solution in some cases.

Rachel Vahey
Head of Pensions Development
AEGON Scottish Equitable