August 2008

Annuity Roundtable

Tailored to fit

Helen Morrissey: A lot of comment in the media over recent months has been saying that annuities represent poor value for money. I'd just like to start off asking people on the panel to what extent they think that this criticism is deserved?

Matt Trott: I think it's thoroughly undeserved. A number of academic reports have been published that prove annuities do represent value for money. I think we have a perception problem here, and there's a number of reasons for it. Number one is that I don't think people appropriately value the insurance element of annuities. I don't think they value the fact that they provide customers with a guaranteed income for the rest of their life, regardless of how long they live. Secondly, research shows that people consistently underestimate their life expectancy. If someone underestimates their life expectancy they're going to underestimate the amount of income they receive from an annuity.

Bernard Footitt: I'm afraid if you live in a relatively low interest environment then annuity rates are going to follow rates downwards. I think they're two-thirds what they were 10 years ago. Notwithstanding that, I did some research for a piece I wrote recently and looked at our own annuities. I found that males at 60, 65, and 70, when you divided the annuity income they would get into the purchase price, all of them could outlive the number of years over which they got their money back as gross income. As a 60 year old, it's almost six years, just by conservative interim life tables so in that sense they represent good value. I just think it is people's perception, for example, they believe all sorts of misnomers, like 'the insurance company keeps your money if you die' and so on. They don't realise that they've benefited from the early deaths of other people when they set up their annuities.

Nigel Callaghan: I guess this may be a rarity, one of the few questions where we're all agreed on but it's been shown time and time again that annuities do give fair value for money. Crucially it's only at the top end of the market that fair value is available. In today's market an annuity does one thing really well, it carries on paying. As long as you draw a breath you're going to get your money. The certainty that gives lots of investors who need that absolute guarantee is worth a lot and I think the market tends to overlook that.

Athole Smith: Another thing to add is that the annuities market has scale, there are hundreds of thousands purchased every year, that means servicing costs are low and advice costs are low compared to other products.

Matt: I think the proof of the pudding is in the eating, and I think our IFA colleagues here will help me in this. In an industry that has been tainted by mis-selling scandals, how many complaints do we get from annuitants saying that they wish they hadn't bought their annuity? My understanding is that annuities have very low levels of complaint factors. I think people who buy an annuity are generally very happy with them.

Athole: Annuity rates are also highly competitive. There's half a dozen companies changing their rates pretty regularly, leapfrogging each other. You couldn't say that they are ripping off the customer.

David Marlow: It's a knowledge gap though, isn't it. The majority of members of the public are not interested in annuities until they're getting close to the point where they're going to have to buy one. So their understanding then goes from very little to having to become quite an expert over a short period of time.

Athole: Rates have improved by about 10% over the last two years.

David: Sure, but we've been checking rates since 1991, and if I was to do a comparison with today's rates and very early 90s, it's not two-thirds, it's about half.

Nigel: All of that's true and, as David said, I guess we're pretty well informed, but to the average person first coming to an annuity there is a perception that it is poor value. However, all we can do is to give the investor some context as to what an annuity will actually do today given increased life expectancy and relatively low interest rates.

David: The underlying bit that I would ask for a different point of view on would be level and inflation-proof. We would want to ensure that the consumer is aware of these options, but trying to make a comparative value for money judgement on the level versus an escalating one is a far more difficult equation to make.

Matt: The problem with RPI escalating annuities is the lack of appropriate investment backing. For a level annuity it's relatively easy for providers to back or to invest their annuity assets in corporate bonds or other assets which provide a reliable fixed rate of return for providers. That's not the same for RPI-linked annuities, just about the only investment backing that providers can get are government gilts. These offer a much lower return for providers that can be passed on to the customers in terms of rates. However, I certainly do agree that perhaps there are more effective ways of inflation-proofing a client's retirement income.

David: A lot of people's inflation protection hasn't been built in and they haven't used the excess to invest in a strong financial plan that combats inflation. It is human nature. We find the vast majority of people, even when they've been educated, still opt for level.

Helen: How aware is the general public about inflation? There's so much research out there that shows that for people in retirement it has a huge effect. I went to the launch of the Scottish Widows Annual Pension Saving Report, and something like 45% of people are not looking to inflation-proof their pension at all. I don't know if that's down to a lack of awareness or is it, as you say, 'I want maximum income now; I don't want to think about tomorrow'?

Claire Webster: We've done a number of pieces of research and we get the same thing coming out, people understand inflation and they're aware of it, because they have generally felt its effects. However, it's the big divide between what they know and what they actually do when it comes to 'pressing the button' and buying an annuity. It also goes back to Matt's point about people's underestimation about how long they will live.

Eyeedul Haque: People are actually looking at annuities and they're buying them for the here and now, which basically means they will take the higher income at outset, especially where they've got to live a minimum of 15 years to catch up with an RPI-linked inflation. At MGM we've actually carried out research and inflation in the pension world is actually about 7%, so it's considerably higher than RPI is at the moment. At the moment there aren't any products which will cater for the increased cost of living.

Helen: What kind of strategies are there for those people who do have an awareness of the effect of inflation and want to do something about it but don't necessarily like these annuities?

Nigel: Some people are opting for a halfway house. If they are looking to buy an annuity, they may well purchase, for instance, a fixed 3% escalating annuity, which relatively is giving better value for money than the RPI-linked annuity. They're also mixing and matching, with annuity rates being up 6% this year, 12, 14% over the last two years. People are maybe investing half of their pension policy now in order to secure those rates and leave the rest in the markets. So as is often the case, there's no one answer. There's one thing I do want to come back on. It always strikes me as quite strange that as an industry we sort of point the finger at people retiring. The choice that people have to make at retirement is often pretty stark. As an adviser, in relation to escalation, you are effectively saying 'Okay, take less income now, but you're likely to live 20 years, so you will get it back in the long run' That's no different from employees, having a salary review and saying 'Okay, I understand it's tough times, I won't have a salary increase for five years'. We live in a harsh world and people have to make imperfect choices.

Matt: I think one example of that is the growth in the equity release market recently. People are finding later on in life that the real value of their annuity income and their pension income is reduced, they're now looking to other assets to boost their income, whether it's equity release or other investment, there are other solutions out there.

Athole: Another solution is a with-profits annuity, which some providers offer, and gives access to real inflation-linked assets, which can help protect customers against both living too long and seeing the purchasing power of their annuity diminish.

David: We're not finding anybody buying any inflation-proofed guaranteed rate annuities, full stop. I would encourage people to try and get beyond having to have all of their income guaranteed, and if you're prepared to take some investment risk, you don't need to sacrifice so much in starting income, and you can still participate in inflation protection, but many people don't see that as a pension.

Bernard: It's frightening really when you look at almost 90% of annuities purchased last year, which incidentally was over 400,000 contracts, 89-90% of those were purchased with a pot of less than £50,000. Now if that's your only pension saving, it's difficult to do mixing and matching, it's also difficult to do inflation-proofing. I accept that within those figures there may be people who have several pots, all counted in there as single pots, but nevertheless there are a number of people who only have one pot of less than £50,000. The other paradoxical thing I find is that we all buy the headline inflation figures of 2 1/2 or 3%, knowing full well that it's above that as far as real-price inflation is concerned. I also find so-called industry experts quite dismissive of inflation, saying they don't think 2-3% will eat into an individual's income purchasing power. If you spread that over 20-25 years, and you're looking at the purchasing power halving, just at the headline rate, but if you look at round about 7% ...

Athole: Your income halves over 10 years.

Bernard: I'm not that averse to variable annuities, I just hate the name. The number of phone calls I field trying to explain to people that it's not an annuity and it's not variable is terrible, but that's another story. I do believe in mixing and matching where possible but at the lower end of the market, it's an annuity or nothing.

Helen: One of the big things I've noticed since I've been involved in this industry is when people talk about annuities what they generally mean is level, single life annuity, whereas actually there's so many different types of annuity. Where do you see the main areas for growth in the annuity market, considering there is so much on offer?

Athole: We actually see most product areas expanding in the future. The annuity market's quite odd in that you've got polarisation at the moment, you've got the conventional annuities at one end and unsecured income at the other end. With-profits fits nicely in the middle in that it protects customers against the longevity risk and it allows some investment risk, but we also expect to see other products such as the third way products competing in that area. On the conventional side, we would see the enhanced space getting bigger. With standard annuities, we've already seen providers come in offering weighting factors other than the standard age, sex and fund size. I think it's inevitable that other providers will have to follow, for fear of anti-selection. So I would say we will see growth in all of these areas.

Helen: One of the big stories has obviously been enhanced. Again, for years people have been saying there's so much room for growth in the enhanced annuity market, we need to raise awareness of it. I think business volumes are growing now.

Eyeedul: You will actually see that there's been quite a few new entrants into the market over the last 12 months. The reasons for that, a lot of companies have actually been seeing a lot of their pension pots going to the enhanced specialists via the open market option. So by launching their own enhanced solutions they can actually retain some of that business, and also by the open market option actually win business, where potentially they're actually losing cases each year. So there is an increased choice but while choice on one side is good, if you get 15 or 20 providers, it will increase administration costs for the IFA.

Athole: Although technology is making the provision of rates to advisers far easier now.

Nigel: I agree with what you're saying, competition is great, I'd love to see 15 players in the enhanced market. I would welcome also the use of electronic communication and a way of bringing down costs by insurers and for distributors, because a) that would increase the profit margin for both parties, but also hopefully it would mean that rates could sharpen up even further. I do think the annuity market is at a real tipping point. I think last year for the first time the enhanced annuity market breached £1 billion. I think that's going to force insurers to follow suit, otherwise they will end up being selected against.

Matt: I would take it one step further and actually say that the enhanced annuity segment as we know it will disappear shortly. At the moment we have a standard annuity, an enhanced annuity, an impaired life annuity, and a lifestyle annuity. However, these are actually all merging. What we're going to have is a single annuity market which is going to be a lot more personalised, where all rates will be based on the individual circumstances of the customer. In this case, I don't think it's going to be long before we will cease to think of an enhanced annuity market, we will just see a personalised annuity market.

Bernard: Don't they say up to 40% of people could qualify for an enhanced rate?

Matt: We say there's about 40% of people who could qualify, but only about 10% of people actually take one up. So a quarter of people are buying the standard annuity when they could be given enhanced rates.

Bernard: But about 10% of healthy people, if they shopped around on the open market, could get a better annuity rate as well. I do agree with what you say, Matt, that it will eventually merge with the development of underwriting systems where you've just got to put details in and it will give you a personalised rate.

Athole: One consequence of this will mean that, in time, the healthiest lives will get poorer rates than they get today, almost certainly, and they will then, I would suggest, shop for non-standard annuities, as in with-profit or unit-linked or drawdown.

Nigel: There's got to be winners and losers, there's only one pot of money.

Matt: I think from my perspective, we talk about winners and losers here. I'll twist that round and say actually those in good health are getting a really good deal at the moment, and to be honest it's not fair on the ones in ill health who are paying for that. I think the move to more personalised rates is a much fairer way of doing it.

Claire: At Norwich Union we've just launched postcode and relationship status and smoker status as factors on our standard annuity, and I think the work that we've done shows that there's a significant amount of cross-subsidy going on between groups of customers in the current standard annuity market.

Eyeedul: If you said 80% of cases can be below £30,000 in terms of the annuity purchase price, what are providers and IFAs doing to service the bulk of the market? Yes, we have inherited the situation where consumers are not saving enough for their retirement pot that also coincides with people not understanding what annuities are. So when people do come up to retirement, they receive a letter from their pension provider saying 'You can exercise your open market option', again the consumer doesn't know where to turn. When they do have a pot, for example, of £30,000, there will be advisers out there who won't be able to actually financially cater for them in terms of offer them a full advice process and it's at that part of the market where those people probably need the advice the most.

Bernard: If you've got £30,000, there's not a lot of room for manoeuvre, nor is there much margin for error. It is all about access to advice, and this is the problem. That's why RDR has come out with things like guided sales. I think that's a move to get people at least into some form of advised process, but it is costly to advise people at that time, when the pension pot is so small, and commercially there's not enough in it for a lot of advisers to be able to do this.

Helen: I think only about three providers will transact pots of £10,000 or less on the open market anyway. You can't offer an open market option when there's not an open market. The adviser also has limited options, because it isn't a profitable business for them to transact.

David: We can't afford to help the customer, certainly not in an advised service at those kinds of levels. If we charged them a fee, the fee charge that we'd put in place may negate the value of the uplift that we can achieve for them, at least for a couple of years to come, it is a really tricky challenge.

Matt: The benefits are there for the customer if they qualify for enhanced rates. If he's a smoker for instance, even with a £5-10,000 pot, he could increase his income by 20-30% by purchasing an annuity on the open market option. Now, if an adviser charges 15% commission, which is absolutely unheard of, and that comes off the rate to the customer, the customer could still be going to get a 15% higher income than he would've done. That was a deliberately obtuse example, but it shows that the benefits are there to the customer if they shop around.

Nigel: The starting point has got to be that you've got to have the open market option as the default, because there is just such a compelling reason for there to be. If people's income can be increased by such a huge amount, then surely that's got to be in the consumer's interest, it's in the government's interest because it puts less people on means tested benefits. So I fervently believe that the open market option should be the default option.

Athole: I would disagree with that, I think you should make it absolutely clear to customers that the open market option exists and it's there for them and you should shop around, but it doesn't mean they'll get a better rate from the market than they will from their own provider.

Nigel: If someone is encouraged to view all the options, then if they choose to come back in and buy the annuity, fantastic, that's great, because they've made an informed decision. If 40% of retiring investors are entitled to an enhanced annuity and currently there is a huge mismatch of only 10%, a quarter of those entitled are accessing it, I don't see how that can be justified.

Athole: There could be other reasons customers don't go to the open market, they could have a guaranteed annuity.

Nigel: In which case investors should be encouraged to see what is available in the open market. If having done so, then fine they can come back to their pension insurer. But investors certainly need to be encouraged to go out and see what the world looks like.

Matt: I think the customers would be willing and happy to shop around if they knew how to. I think this comes back to what we were saying about access to advice. The literature has got to clearly explain that they've got a right to shop around, but also how they do it. I have some stats here and according to the ABI, about 73% of the conventional annuity market goes through a financial adviser. Of those broked annuities, 42% purchase an annuity with the existing provider, and 58% swap providers. If you then look at the part of the annuity market that is not broked, 95% of people just buy the annuity with their existing provider. That to me says that you get a much much better deal if you go and talk to a financial adviser.

Bernard: The shopping around process has to be pretty slick, and that's down to the insurance companies, the adviser and even the client. I've heard horror stories of forms being sent to clients to sign for the open market option and its taken them 3 1/2 weeks to get them back, and then they've grumbled that it's taken the insurer a long time to sort their annuity out. I partially agree with what Nigel says. I'd like to see it as the starting point, not necessarily the default.

David: There's a huge book of business in the UK, people who are stuck in a closed book, and they're the worst offenders for speed of response, speed of quotes, speed of actually remitting the funds, and gives the industry a bad name. I don't see the ABI's best practice actually working in terms of delivering a real benefit to consumers. If you're not going to talk about radical ideas and pushing ahead, it's just another exercise in providing pieces of paper which don't do the job.

Helen: How do you think we can move forward from that?

Nigel: The industry has had years to offer consumers a better deal and to date it hasn't taken it up. The market is set to triple in the next five years, which is one of the reasons, being cynical, I think there are some providers that are holding on to the current system because they do not want to see that money move. If the industry doesn't go out of its way to give investors a better deal than it's currently doing, which as I said earlier, is going to be best achieved by strongly encouraging people to go out of their front door and to see what the world has to offer - anything short of that is doing a mis-service to investors.

Athole: Larger providers are getting together to try and ensure that money does move about faster. We've just done a pilot with a couple of large companies, and I think the ABI is going to roll that out, but that will only work if everyone participates.

David: I don't think they will, I don't think I'm being overly cynical, I think it is Nigel's point regarding the commercial reality of those books of business. I think part of the challenge might be around treating customers fairly, to what extent would it be easy for those, where they don't have competitive rates, to justify not adopting a best practice that's in the industry. Maybe I am being cynical, I don't think it will work, and therefore I think the outcome is probably that we're going to be policed, whether we like it or not, and the regulation will happen to force certain standards to be adhered to.

Eyeedul: I think what we're calling for is that the open market does have to be promoted, and providers and IFAs have to streamline a process so that it is easy to understand. We've seen things in the past like common quotation forms being promoted to simplify the process for instance. But also the life offices, you mentioned the delays in actually transferring funds from one to another, I was reading in some of the financial press a couple of weeks ago, ScotEq on their standard annuities, what they have done is increase their quotation guarantee from 14 days to up to 21 days, hoping they can move that money within that period. It can take on average about six weeks to transfer the funds from one company to another. If you look at the banking industry probably about 15 years ago, people infrequently moved their current accounts from one bank to another, because you had to move the standing orders, you had to move all your direct debits from one bank to another. Whereas if you look nowadays, it's relatively simple to move all your banking affairs from one provider to another. I think in terms of the life and pensions industry we need to follow suit quite quickly, because to take six weeks to actually transfer funds is pretty shambolic. It is because of these typically long delays that MGM Advantage introduced a 45 day quote guarantee.

Nigel: If either by compulsion or by the industry finally waking up and realising it's got to act in investors' interests, you create a market where it becomes the norm that people do shop around then a lot of insurers will realise that there's money to be made and five years from now we'll be having a different conversation.

Helen: I think the internet has a big part to play hasn't it? People wouldn't dream of taking car insurance or home insurance without going on one of these compare websites. If people find it quite easy to use these sites, can you see us going down that route with annuities perhaps?

Claire: I think it's an important tool, because the bulk of the market are in this smaller pot territory, and a lot of those people will not relate to the concept of a financial adviser. We need another way of getting 'advice', to them. It's easy to compare rates through these sites. However, many people perhaps buy an insurance product on the rate and then they find that there's a huge excess or it doesn't cover certain things that one further down the list might have done. So it's getting the right annuity as well as the right rate.

Helen: Do you think with regards to raising awareness of the open market option, do you think there's a role there for the Thoresen money guidance scheme going forward?

Matt: I think it would be absolutely worth trying. We know that there's a very big problem in that end of the market. As we mentioned before, the lower end of the market is not seen as cost-effective for advisers to provide full advice. Still, those customers could benefit from some system that would help them shop around. If there's an alternative way of people shopping around, without necessarily going through the full cost of full advice, then I think it should be explored, absolutely. Again, the problem's not necessarily the big companies already in the annuities market. We've got to force those closed-book providers that are not making it easy for people to shop around; they're the people that the scheme's got to be targeted on.

David: I think it's good that you're providing a wake-up to some, but pointing somebody to the FSA site would give them lots of rate data, and there'll be some good education, but they can't practically exercise that choice in any way with the FSA.

Nigel: You're absolutely spot-on Dave. The reality is that a high percentage of retiring investors are buying an in-house annuity. We might disagree about what percentage that is, but it's a small figure, and as they are not getting any advice; they are unable to make an informed decision. Even if the only help investors get is a comparative website that they are actively encouraged to access and one that is really easy to navigate, that is a step in the right direction.

David: I totally agree, I'm quite belligerent about the problems we've got at the moment with the lack of service levels from some of the offices that we're dealing with. You'd have to have that participation to make an engine actually work. At the moment, if I want to buy my car insurance I can choose to buy it, I can't hit a button and make sure that everything happens to effect my annuity purchase.

Eyeedul: I think that is starting to change, because you have some of the enhanced providers going down the online route. The vision that I have is that within five years, buying annuities could be as simple as buying car insurance.

Matt: This is one step in the right direction. An IFA can already type the details into one computer screen and that will ping all the information off to different companies. Okay, it's only a couple of them that are coming back with a quote, but that will expand, I have no doubt. The next step then is a 'buy online' button.

Nigel: If it does get there, what would be the implication on price for annuities?

Matt: Well it should streamline service and processes, cut costs, and improve cycle times. Doesn't that sound good?

Helen: If we can just move briefly into the alternatives to annuities. I went to a debate at the Cass Business School probably about two or three months ago, and it was entitled 'Will drawdown replace annuities?' What do you think of that question? Do you think drawdown could or should ever replace annuities?

Claire: I would say it probably can't replace annuities. Based on the numbers that we've already discussed the mass market does not have enough money to be able to consider flexible solutions like drawdown. Having said that, I think drawdown has the potential to appeal to a wider audience, particularly with the new products coming in which have really stimulated innovation in the retirement market, which is all for the good.

Athole: Even for richer customers with bigger pension funds, there comes a point, I think we mentioned earlier, where it makes absolute sense to annuitise, because of the mortality cross-subsidies.

David: Purchasing habits though do tend to follow confidence in the stock market as well.

Athole: In 2000 there was about £4 billion into drawdown, and there was a 20% drop in Q1 this year, due to stock market sentiment.

Bernard: Yes. However I think they're complementary as opposed to either/or in the right environment. Again in relation to the "Cass" big debate we've had, there are a number of people stuck with no choice - it is an annuity or nothing. There are many fewer people who don't have to worry about markets and so on and can manage their financial affairs where drawdown is the natural home for that part of their retirement income that is pure pension income. We've not considered all the other assets that the high net worth people hold that can produce income at times when markets are not wonderful. That's the beauty of drawdown, you can turn the income on and off, and adjust income much more easily.

Athole: Even if drawdown was allowed as a total replacement for annuitisation, the government might insist on some sort of minimum income to stop people running out of money, and that would be incredibly complex to try and manage.

Bernard: Well they've put that ceiling up, haven't they, with effectively compulsory annuitisation. Even if you've not taken any income from your drawdown before you're 75, you're going to have to take a proportion beyond 75 if you go into alternatively secured pension. So they just moved the point at which you must draw some income up to 75 so that you don't have to rely on the government.

Matt: I think there's a danger with some of these debates that we are reinforcing the negative perception of annuities. Indeed, our own discussions could be interpreted as stating that annuities are simply the product for those that can't afford to go to drawdown. I strongly believe annuities are a cost-effective way of meeting many customer needs, and for that reason I think that we should be much more bullish about the annuity market and I think, yes, it will continue to flourish. I think it is a good strong product for many people at retirement.

David: Well I was going to say that's part of why you end up with this perceptual problem. People have heard through the papers they've got to buy an annuity and it doesn't represent great value for money. That's what we've got to combat.

Matt: I do think again the age 75 limit is one of the biggest barriers to the savings gap and to the entire pensions market. I think we need to remove that link and that perception that a pension means you're forced down an annuity. You need to get the messages out there at a very young age, that you do have flexibility. A pension is nothing more than a long-term investment plan, and you will have options when you get to retirement of how you convert your accrued fund into an income. I'm still convinced that when those people do get to retirement an awful lot of them will continue to want to buy an annuity, because it will be the right thing to do, but I think that this issue is holding back the entire pensions market.

Helen: You mentioned the Age 75 rule, and I know the Conservatives had proposed, I don't know if it was abolishing it altogether or moving it on to a later age. How likely can you see this happening in the near future?

Eyeedul: Well personally I don't believe there will be the abolition of the right to buy the annuity. I do see that the age limit may be increased in line with longevity. So people of younger generations unfortunately are having to work longer in order to provide a pension which they can then draw on in the future. I think the compulsion for annuities may disappear but there is that risk that without sound financial advice, there is a huge risk of this mass proportion of the population running out of money and then relying on the state.

Bernard: Again, there is no compulsion to buy an annuity at any time, they just make it difficult at 75 not to.

Nigel: I personally think it's a racing certainty at some point in the next few years, possibly the next administration, that that age will be pushed back, and that's to be welcomed. Given the much longer life expectancy, the age 75 is simply outdated.

Matt: I can't imagine it being done by this government, no. I can't imagine it even being entertained by this government, to be honest.

Bernard: I don't think there's any appetite for any great massive radical upheaval again, even in a new administration, if there is one, in two years or so. But I certainly think there'll be some tinkering with the age 75 rule.

Claire: Again we're talking about an impact on a relatively small proportion of the market, because, going back to a point that's come out, the mass market, if they continue to retire in their 60s, they will inevitably buy an annuity as soon as they need to, because they will need an income.

Helen: If we just move on to variable annuities. Variable annuities have been around for about 18 months now and they've been put forward as the ideal middle way, if you like, between annuities and income drawdown. If we can discuss what impact you all think variable annuities are going to have on the market.

Bernard: I was at a conference a couple of weeks ago, and Nick Bamford was asked to answer a series of questions, one of which was this particular question, and he just said one word on his slide 'None' - it has no impact at all in his practice. You can end up with a bigger fund in conventional drawdown, properly balanced over 30 years, that you start with, and doing the same thing but with a guaranteed rider, and there'll be 146% lower fund available at the end of 30 years for a guarantee that people have never had to draw on, many probably die five years before they may have needed to fall back on the guarantee. So I don't think it's going to be that great an impact, unless the pricing is right, and I think the newer ones coming out now are much more sophisticated, much more value for money, but still doesn't get over the fact that it's more expensive than a conventional drawdown or an annuity.

Athole: We're looking quite closely at it, and it's very hard to construct something that is cost-effective from the customer's perspective and simple to understand. You've also got the drawdown legislation to superimpose on any design you might have around having to annuitise or having GAD limits imposed on you, that could be pretty difficult to explain to a customer. However, I think it's good that there are other options coming into that middle market. It's good that there is more discussion on these products, but we are struggling to actually see them taking off in the short-term.

Nigel: How much cheaper do insurers think the guarantees associated with these contracts could become?

Athole: We offer investment in with-profits within income drawdown, and that's essentially like a variable annuity in that you get your money back at 75, plus any growth, less what you've taken out, and our charge for that is, it depends on how long you've been in and how much money you have, but it's between 0.45 and 1.25. That's offering the same type of guarantee as you'd get on a variable annuity, but we couldn't replicate that on a variable annuity structure.

Matt: It's interesting, and the comment was made earlier on that the term 'variable annuity' is not correct, it's not an annuity. What we are talking about is a simplified guaranteed drawdown fund. However, I do think it's very interesting to look at it from the annuity perspective, and I think that this is where there is a lot more potential growth. This is where the with-profits annuity and the investment-linked annuity sectors are coming from. If you think about what the customer needs, many of them can be met from existing products. For example, a with-profits annuity provides a base income guarantee - different providers sell it different ways, but LV= offers a guarantee that income will never fall below the 0% ABR level, but you also get the benefit of investment performance. If you throw in value protection as well, there's also a possibility of a lump sum death benefit. I think there's a lot more we can do to promote that part of the market, and I think there's a lot more growth within that sector before we start getting too complicated, creating a new structure which doesn't necessarily have to be created.

Nigel: I certainly think, wherever the market progresses in terms of third way annuities, that the current charging structure of third way annuities is almost certainly an accident waiting to happen. If you've got a 3, 3.5, 4% management charge and someone is taking 5% income, a regular return in excess of 8 or 9% will be needed, that is a huge hurdle to meet every year.

Helen: Are you seeing much client appetite for this kind of product?

Nigel: Yes, we're getting some clients asking for them. However, their interest doesn't last very long as soon as you start talking about the costs associated with them, and their complexities. Watson Wyatt, with their best case projections, were saying that it's going to be no more than 5% of the market in nine years' time. I think they will remain a niche product for the foreseeable future.

David: I would warn advisers that if you're ignoring them, you're not doing your clients a great service in the first place and also from a liability point of view you're not really covering yourself in an audit trail. That's where it becomes difficult, because from an adviser's point of view you've got to know all the products inside out and yet a lot of them you don't ever expect to use.

Bernard: With that last point in mind, 'know the products inside out', it's quite evident, if you talk to some of the early innovators who brought these products over here, they quite deliberately want to differentiate their product, and so there are different riders, different pricing for the riders, different ways they work. Personally I welcome the variety in the marketplace now but I think there is a danger of 'sowing the wind and reaping the whirlwind' perhaps when using these complex products.

Helen: If we just go round the table before we finish and just talk about where you see the annuity market going from here. Do you think there's any extra room for innovation? And, if so, where do you see that coming?

Eyeedul: Well I do see there has been quite a lot of innovation over the recent years, and you can actually see there's been lots of product providers, for example, joining the enhanced part of the market. We've seen different types of products, variable annuities, with-profit annuities, also adding choice, which is always a good thing for a consumer. Again, it does create challenges for IFAs as well, because, as you were saying, David, IFAs have to get to grips with these products, understand these products, and if possible recommend these products where the actual condition is right. I think where the whole process breaks down is you do get product providers building products without actually consulting IFAs to see if there's a need for the product and can it actually be sold to the end consumer. Having said that, in terms of the future, I do believe everyone will have some level of individual underwriting, so whether it is on height, weight, postcode, smoker status, the market will become more and more segmented.

Athole: Providers need to talk to each other so that life is straightforward for the adviser, so the adviser doesn't have to go to six different underwriting systems from six different providers and give the same information in a different format. The systems have to be compatible, and that's quite a hard thing to work to.

Claire: I think there's a couple of areas for development going forward. Firstly, there's this idea of the convergence of the enhanced and standard annuity markets, and I think that's a win/win for everybody, I think it's fairer for customers. I take the point earlier about how you define fairness, but I think there's a strong argument that it is fairer for customers. I think if we get the technology element of it right and the business model right, it's great for advisers, because they will no longer have to second guess which product to go for - whatever information you have on your client will get put in and they will then get the rate that's right for them. And secondly, I agree with Matt's point earlier, that there's a lot going on in the variable annuity and guaranteed drawdown space. It feels like there's also more to come, perhaps more innovation from the annuity angle. What's so positive is that we're at a time where the retirement income market has never enjoyed so much attention and I think that has sparked some important innovation.

David: I think education of consumers is perhaps where a lot of our focus is going. Work-site education in particular for us I think would be a major strand so we aim to keep the financial conversation running longer, so it's less of a kind of 'Wake up, you need to be alerted to something coming', it's more a natural progression towards accumulation and decumulation.

Bernard: Yes, I think that accumulation through decumulation needs to be much smoother. I share Matt's bullish view about annuities, I do agree that once you get these automatic underwriting engines in place and that they get really slick, you will have a spectrum of personalised annuities. There's now room for innovation by stealth really, rather than a big bang, in the annuity area, it's a question of tweaking models that are already there and making them better.

Athole: One area we haven't talked about but we've had quite a bit of feedback from customers is around money-back guarantees, the idea that 'if I live or die, I'll get my money back'. You can get that to a certain extent just now to age 75, 35% tax, but that's a bit of a confusing message, and it's not necessarily fair if basically a tax-payer has been saving to get the 35% charged on death benefit. If there was some sort of change there to allow proper money-back guarantees to be offered to people, I think it would encourage a lot more saving in the first place, which would lead to bigger pension pots, because I think psychologically people just don't like the idea of losing their money.

IFA Profiles

Nigel Callaghan is pensions analyst at Hargreaves Lansdown

Nigel is a pensions analyst working within the Hargreaves Lansdown research team. He is frequently quoted in the media on pension issues and has worked in financial services for over 20 years.

David Marlow is marketing director at Alexander Forbes Financial Services

David gained his grounding at Equity & Law Life Assurance Society (now AXA) in a variety of roles from 1984 to 1998. From here he went to National Mutual (now LV=) as product development manager and then joined The Annuity Bureau as head of marketing in 2000. Since May 2004, David has been marketing director for national IFA business Alexander Forbes Financial Services.

Provider profiles

Bernard Footitt is technical support manager (pensions) at Canada Life

Bernard joined financial services in February 1986 and has since developed a high level of technical expertise in pensions.

Latterly, Bernard provided assistance on a consultancy basis with pensions development for National Australia Bank working with the bank's IFAs to develop their pension business book in the run up to pensions simplification.

About Canada Life

Canada Life was founded in 1847. With assets under administration in excess of £193 billion as of year-end 2007, Canada Life now has an even stronger platform for continued growth as a world-class financial services provider.

In the UK alone Canada Life manages over £10 billion of pension assets.

Eyeedul Haque is proposition manager at MGM Advantage

Eyeedul joined MGM Advantage from Partnership Assurance where he gained broad experience of the annuity market working across operations, product management and sales. He is an industry specialist and was responsible for developing the Common Quotation Request Form used by all major enhanced annuity providers.

About MGM Advantage

Formerly known as MGM Assurance, the company repositioned itself as MGM Advantage in June 2008 when it launched a wholly-owned business unit called MGM Advantage Designs for Retirement to focus on the wider retirement market.

Athole Smith is head of product management at Prudential

Athole has worked for Prudential for over 10 years. He has worked in different areas of the business including customer services and product management and is currently responsible for the design and development of retirement income products including with-profit annuities and drawdown. He is also responsible for Prudential's annuity pricing. Athole is a qualified actuary with over 20 years experience in financial services.

About Prudential

Prudential is a leading life and pensions provider to over seven million customers in the UK. It provides a range of products including annuities, corporate and individual pensions, with-profits and unit linked bonds, savings and investments, lifetime mortgages, healthcare and protection.

Matt Trott is head of annuities at LV=

As head of annuities for LV=, Matt is now responsible for the development and delivery of the LV= annuity proposition, including its range of enhanced annuities and with-profits annuities.

Matt entered the financial services industry in 1992. Having originally joined National Mutual Life, his career has involved him working in all parts of that and the subsequent GE Life business. Since 2004, he has been focused on promoting enhanced annuities within the financial services industry, and helped build the industry's first on-line enhanced annuity quotation facility with GE Life.

About LV=

The LV= Flexible Retirement Solutions business, part of the LV= group, launched in January 2008 and offers a range of capital and income retirement planning products. Our products and solutions offer a brighter future for those who are planning, or already in, retirement. LV= serves more than 2.5 milion customers and members, and manages around £8 billion on their behalf.

Claire Webster is annuity marketing manager at Norwich Union

Claire has worked in financial services for seven years and has held a variety of product development and marketing roles within Norwich Union with a focus on the IFA channel. She celebrated A-Day by joining the annuity marketing team in April 2006.

About Norwich Union

Norwich Union is the UK's largest insurer and offers a comprehensive range of retirement solutions including bulk purchase annuities, individual annuities, drawdown, ASP and equity release. All of these are in addition to a wide portfolio of investment and protection products.

Helen Morrissey
Editor - Retirement Planner
Incisive Media