What’s new in the retirement market?
The answer is that annuity product development has ground to a halt, but there are some interesting developments in the advice process and ‘centralised advice propositions’ seem to be the talk of the town.
One of the most important innovations in the area of advice has been the development of centralised retirement propositions. The idea is to have a structured, step-by-step advice process that specifically meets the needs of client who are taking advantage of pension freedoms. This is more complex than it might seem because there are so many different factors to take into consideration.
There are some challenging technical issues such as managing sequence of returns and calculating appropriate levels of sustainable income. There are also some complex client behaviours to manage. The advantages of a centralised retirement process are that it not only ensures better compliance and better product selection, it also results in more consistent advice to clients.
My approach to retirement advice has always been to separate the strategy from the tactics. Strategy is about formulating a plan and the tactics is about finding the best solution. There are interesting developments on the planning side with new cash flow modelling tools and some interesting work on sustainable income and safe withdrawal rates.
There is a trend away from deterministic models to stochastic cashflow modelling tools. Stochastic tools use lots of historical data to illustrate the likelihood that something will happen, such as the client running out of money and provide a range of outcomes.
Deterministic tools are much simpler and make a specific conclusion based on the values entered by the adviser but the main problem with deterministic models is that it does not take account of sequence of return risk.
On the tactical side, it does not have to be black or white; an annuity or drawdown because there are solutions which bridge the gap between totally secure income and complete flexibility, such as fixed term income plans.
These plans solve the problem of how to get a guaranteed income without losing control by purchasing a lifetime annuity and retaining flexibility and control without taking the risks associated with pension drawdown.
The key to understanding fixed term income plans is to recognise the two different parts; the income that is paid for a set period of time and the maturity amount which is a lump sum paid back into the pension pot at the end of the term. The most appealing feature is the maturity value that is paid at the end of the term because this can be used to pay a lump sum (taxed at the recipient’s marginal rate of tax), purchase an annuity or remain invested under drawdown rules.
I do not predict much innovation to the basic annuity because the unique advantage of the income for life comes from the mortality cross subsidy and any attempt to add bells and whistles to annuities reduces the benefits and attraction.