The annuity king is dead, long live the king

There have been varying predictions of how much the annuity market will shrink, with RBC Capital Markets’ analysts predicting a whopping 90 per cent, while Barclays forecasts the value of new individual annuity business to shrink by two-thirds from £12bn a year to £4bn by 2015.

Already providers are reporting falls of around 50 per cent during a period in which only transitional rules that have boosted drawdown are in force, with the likes of Legal and General and Prudential revealing the final two weeks of March saw enough of a slowdown to drag down Q1 sales overall by 40 and 35 per cent respectively.

The Budget has kick-started a change that many in the market - including the regulator, which had just announced a competition probe into single annuities - had clearly deemed was necessary. But while the reforms are the catalyst for change, they are not the only factor in how the market will develop.

Nigel Barlow, director of product development at Partnership, adds that increased longevity, the end to the default retirement age and the advent of auto-enrolment will all have an impact as to what the retirement market looks like in 12 months’ time.

While market commentators agree that it is too early to say what traditional annuity providers will be doing in a year’s time, there is agreement that they will have to be far more innovative in order to survive.

And firms are responding: Aviva has revealed it has sped up product development and already has a suite of alternatives almost good to go, while LV has set up a specialist team to drive the development of new at-retirement solutions.

Substantial business restructuring is also taking place at the likes of MGM Advantage, which is set to shed around 80 roles, and Just Retirement, which is seeking to cut £14m in costs a year and reinvest part into broadening its offering.

John Perks, LV managing director for retirement solutions, says: “In order to survive, firms will need to evolve to suit the new landscape and demonstrate that they offer retirees products that offer the flexibility they require.”

Alastair Black, head of customer income solutions at Standard Life, agrees, adding: “People like guarantees so there will still be a market for annuities, but just not on the same scale as before.”

Annuity options

Short-term innovation is already in full swing, with LV and Just Retirement both recently launching one-year annuities to help retirees who want to take an income but do not want to lock into a product until all the new rules come into force in April 2015.

The products are actually written under drawdown rules and have attracted criticism from outspoken commentator Ros Altmann, who said the effective 0.5 per cent return represented poor value and called for them to be banned.

Partnership also launched an enhanced choice annuity, which is a standard lifetime annuity with a break-clause at the one-year anniversary to offer a similar function to clients.

Longer-term some of the necessary business model evolution and product development will similarly be an extension of firms’ existing scale in annuities, just in a different form.

For example, providers such as Legal and General and Prudential have said they will look to conduct more bulk annuity transactions with defined benefit schemes, with annuity specialists Just Retirement and Partnership following suit and already conducting their first business in this market.

Other options could include the less mainstream annuities, such as deferred products.

Neil MacGillivray, James Hay’s head of technical support, says: “If the annuity providers are not in the bulk annuity market, to survive they will have to innovate and provide the products the market desires.

“One potential opportunity we see is in deferred annuities. For example, an individual reaching say 65 starts crystallising their benefits on a phased basis, and each year uses some of their [pension commencement lump sum] or income to fund a deferred annuity payable at 75.

“This way they can enjoy life while they are active, knowing that in later years they will have the guaranteed annuity income.”

He adds that while traditional conventional annuities are unlikely to survive in their present format, there could still be a market for individually written enhanced annuities that provide a higher income to those with lifestyle or health conditions.

Unsurprisingly enhanced annuity providers Partnership and Just Retirement agree.

According to Mr Barlow, research suggests that a guaranteed income is still something retirees are interested in so there will “still be a role for standard annuities” but it will be “increasingly likely” that people will look for enhanced annuities to maximise the income they can get.

Stephen Lowe, group external affairs and customer insight director at Just Retirement, adds that individually underwritten annuities are “often one element” of a personalised financial plan, “specifically the default method of using pension assets to meet the need for guaranteed income for as long as they live”.

LV’s Mr Perks also believes interest in the enhanced annuity market will grow, particularly for that segment “who would qualify for a light to medium enhancement”.

Drawdown as default?

James Hay’s Mr MacGillivray adds that unless an annuity has a “guaranteed attractive rate, the likelihood is that individuals will elect for drawdown instead”.

Standard Life’s Mr Black agrees, explaining that while there “will still be a market” for enhanced annuities, “the inheritance tax benefits of being in drawdown” might mean fewer people consider this as an option “as they would like to pass their assets on to their dependents”.

Standard Life estimates the drawdown market to currently be around £4.5bn, of which it writes around 25 per cent. Mr Black predicts this market could “double”, as it opens to people with smaller pots who may prefer the “simpler model” that does not rely on government actuary department rates.

Immediate changes means those with £10,000 in a single pot and £30,000 in total can use trivial commutation rules to encash their pension, with most drawdown providers including Standard Life itself reducing their drawdown limits to £30,000 to offer alternative options to annuities for those above this level.

He says: “Even with the ability to withdraw cash up to £30,000 we estimate that unless the fund size is very small, say less than £10,000, they will likely still want to try and withdraw an income from their fund.

“How this is done will obviously change in the absence of capped drawdown limits and people will need advice to secure the right income.”

Mr MacGillivray adds that drawdown “will take the place of the standard annuity market” and James Hay believes this is already being evidenced by the “precipitous fall in annuity business which we have already seen reported by providers”.

Partnership sees a bright future for unit-linked guaranteed products, which are again written under drawdown rules and provide people with larger funds “the flexibility and control they say they want with some of the guarantees they still need”.

The firm is currently looking at launching a unit-linked product, often referred to as variable annuities, and Mr Barlow adds he could not “imagine any provider in the market won’t be looking at them”.

Prudential is also thought to be looking at launching a similar option - and existing providers Metlife and Axa predict that all major life insurers will ultimately look at this segment.

Packaged solutions

Assuming the changes brought by the Budget eliminate unnecessary tax and product barriers, Just Retirement does expect further innovation in product and customer solutions, which it believes will herald a move towards packaged solutions for clients bringing together several products.

Mr Lowe says: “We can envisage packaged products that deliver combinations of guaranteed and flexible income.

“Part of this could be an overhaul of investment strategies in the pre-retirement phase and we also foresee pension or retirement-[new Isa] vehicles being developed to receive cash from those people looking to accelerate withdrawals from the pension environment.”

However, all commentators emphasised that products are only part of what will create a successful environment.

Mr Black says the key focus at the moment should be on advice, rather than products.

Mr Lowe agrees, adding: “Financial advice will become even more important to the new environment to increase the chances of people attaining good outcomes and stop them from making bad ones.”