Finding a blended solution

Now there are more options to consider and increased flexibility is more readily available, the case for a blended solution is stronger than ever.

Here I will use the term ‘blended solutions’ or ‘blending’ to refer to the concept of arranging a combination of annuity and drawdown options (including investment-linked annuities and fixed-term annuities) instead of a single solution.

In many cases, a blended solution of retirement income options produces a better outcome than a single product solution. This begs the question ‘what is a better outcome?’ The rest of this article will attempt to answer this question.

Why consider a combination of retirement options?

By far the most important reason to consider a blended solution is that it may result in better outcomes for clients reflecting the changing face of retirement.

There are many factors to take into consideration, such as:

Thinking about future life expectancy

Setting out retirement objectives

Understanding how much risk should be taken

Working out how to reduce the amount of tax clients will be paid.

In practical terms this means it is more important than ever to separate the strategy from the tactics. The strategy is about setting out a plan for the future and the tactics is about deciding which financial policies best fit in with the plan.

It is also important to remember that a blended solution is also more likely to meet the regulatory requirement that all relevant options are considered. One of the highest priorities for all compliance departments is to have documentary evidence that every client has been taken though a structured decision-making process and to be satisfied that the advice recommendation is suitable and takes account of individual circumstances.

There are a number of ways of justifying the case for a blended solution but the strongest cases can be made on the following basis:

It reduces or diversifies risk in retirement

It enables clients to meet more than one retirement objective

It produces better client outcomes.

Reducing or diversifying risk in retirement

A good case for blending can be made by looking at the risks facing people at retirement and looking for ways to reduce these risks. Generally speaking, people are not faced with binary risks, such as income or capital risks, but a multitude of risks including:

Risk that inflation will reduce spending power

Risk of living longer than expected and running out of income in the future

Risk that circumstances such as health or income requirements may change in the future

Risk that equity prices and or interest rates could rise or fall.

There is no single policy that effectively manages all of these risks. For instance a guaranteed annuity is the only way to protect against the risk of a client outliving their pensions but it does not provide flexibility if circumstances change. Drawdown is the most flexible option but there is a risk that fund values could fall if future investment returns are less than expected and there is a risk that income could eventually run out.

Enabling clients to meet more than one retirement objective

This is where the skill of the adviser comes into play. A skilled adviser will explain the trade-off between income certainty and flexibility and have a process or formula for advising the best solution.

A good advice process is like a two-sided equation. On one side an adviser will have a formula for determining the client’s objectives and on the other side there will be a formula for working out the best solution. This can be a simple equation or a very complex equation depending on the circumstances.

If the circumstances are straightforward the equation can be simplified to a choice between certainty and flexibility.

However, if the left-hand side of the equation is complex, for example the client has multiple objectives, some of which may be in direct conflict, the solution will be more complex and require a combination of answers offering a degree of certainty and an element of flexibility. For example it is common for clients to want some guaranteed income and some flexibility.

Retirement income advice may be as much an art as it is a science so it is important to consider both the behavioural aspects as well as the technical analysis. In most cases the best decisions are arrived at by using a combination of hard facts and soft influences.

Typically clients will be asking themselves a number of important questions, including:

Will I have enough income to maintain my standard of living?

Will my income last for my entire lifetime?

Will I be taking too much risk?

Will I have capital to leave my dependants?

Whereas advisers will be asking themselves a different set of questions:

How do I treat clients fairly – explain all the relevant issues and options?

How do I ensure all regulatory requirements are met?

How do I provide an efficient, cost-effective and profitable service?

The answer to both these sets of questions is to create an advice process that has a customer journey designed to deliver good advice and produces the best possible outcomes. Good advice stands the test of time and so the solution should meets the client’s objectives at the outset and in the future no matter what happens in the financial markets or to their personal circumstances. Although we cannot predict the future we can identify a number criteria to evaluate the likelihood that the chosen combination will provide a better solution compared to a single product solution.

This article is based on a paper commissioned by LV=and written by Billy Burrows called How Mixing Retirement Solutions Helps You Get the Right Blend for your Clients

There is a link at: www.williamburrows.com

Billy Burrows is director at Retirement Intelligence

Key points

The new pension freedoms has thrust the concept of a blended solution firmly into the limelight.

There is no single policy that effectively manages all risks.

Retirement income advice may be as much an art as it is a science.