July 2008

Playing safe with annuities

It is certainly a challenging time for both consumers and the financial services industry at the moment. For the first time in a long while the UK is experiencing a different type of economic climate than ever before, and you only have to catch a glimpse of the news or do something ordinary like put petrol in your car to realise that the 'Credit Crunch' is an everyday term at the moment. Our own recent consumer research among those aged over 50 years old, the LV= State of Retirement Report, has shown that more people than ever facing retirement are concerned about their financial situation. The rising cost of food and utility bills, fears of a recession, rising interest rates and the media reporting of the 'Credit Crunch' were all cited by this age group as contributing factors to their anxiety.

Indeed just a couple of decades ago people could expect to be able to live on a reasonable retirement income from their pension and enjoy a comfortable standard of living in their later years. In more recent years we have seen people living longer than ever before and an environment of relatively low interest rates, which have both contributed to annuity incomes from pension pots being less attractive than the income they may have provided 20 years ago.

So while people are concerned about making ends meet today, and having enough money to live on in retirement, annuities could be a more advantageous option than initially thought. Put simply, annuities provide a guaranteed income in retirement, and are used to make sure people don't run out of money. In addition, as a low risk option, the underlying investments are often fixed interest bonds, which means that for those who prefer to play safe with their money, annuities are an appropriate choice.

With-profits

One area which has seen real growth, and potentially gives the best of both worlds, is the with-profit pension annuity market. Here, policyholders can receive an income linked to a strong with-profits fund, providing them with the further potential to receive additional income not possible under a conventional annuity. So consumers can benefit from the increased returns available from stockmarket returns, compared with fixed interest bonds, for example, while still guaranteeing a base level of income.

However, 'with-profits', annuities can be tarred with the same brush as some other with-profit-based products from certain providers. For some consumers, though, with-profit annuities are the right choice, and what this really highlights is the need for professional independent advice when planning for and approaching retirement.

Despite over 50s admitting that they are more worried than ever about their financial situation as they approach retirement, the State of Retirement Report revealed that more than half (56%) of this pre-retired group have yet to seek professional financial advice at all about their overall financial situation, level of savings and income in retirement. This majority equates to 5.5 million people across the UK, indicating a real opportunity for financial advisers.

There also seems to be a gap between what people discuss with financial advisers and perhaps what their actual needs might be. Of those over 50s who have already consulted a professional about financial advice, ISAs are the most popular topic, with 43% of this age group discussing ISAs, followed by low risk investments (30%), general pension planning (28%), and inheritance tax planning (20%).

Professional advice

Just over one in ten over 50s (13%) who have consulted a professional for financial advice purposes discussed annuities, equating to just over half a million people. However, our research shows that access to specialist financial advice can have huge benefits when it comes to purchasing an annuity.

In 2006 413,013 consumers purchased a conventional annuity. Using a LV= estimate that 40% of consumers buying an annuity could qualify for some form of enhancement, over 165,000 people could have benefited from an enhanced annuity. Moving this on, the number of people who bought an enhanced annuity in 2006 was 22,686. Therefore, over 142,500 people could be missing out on additional retirement income because they have not purchased an enhanced annuity even though they may have qualified for one.

Furthermore, by looking at the average premium of those buying an annuity and the average additional income an enhanced annuity may give to consumers, it is estimated that over £53m of income each year is being missed out on by consumers who have not purchased an enhanced annuity (figures based on the amount of people who purchased annuities in 2006, sources: ABI, Watson Wyatt, FSA, LV= calculations). This is clearly a huge amount of extra income which would go a long way to assisting people's retirement wealth.

What is important in all of this is consumer awareness of their options in retirement, and quality independent financial advice. People's awareness of their right to purchase their annuity in the open market is increasing, and tools such as the FSA's Money Made Clear initiative is clearly contributing to this. However, it seems as though consumers are still not sure how to use their open market option, and they would like to shop around, but are not sure how to go about it, or are unsure about how to choose a financial adviser. Similarly, some advisers may be unwilling to give advice on small funds, leaving consumers unsure about the most appropriate annuity provider for them. We are working with financial advisers to streamline the annuity purchase process so that it is more effective for them to provide annuity advice, and the Government's review into the provision of generic advice should also help.

For people facing retirement, help and advice on how to maximise their wealth and income in retirement is key, especially in the current climate. The industry needs to work with this audience and direct them to professional independent financial advice sources, rather than pretending that there is not a problem.

Matt Trott
Product Manager, Annuities
LV=