Offering guarantees and access to cash sounds like a route to success. But can third-way annuities really have the best of both worlds in the new era of pensions freedom and choice? Emma Wall finds out
In a matter of days, hundreds of thousands of pensioners will be able to get their hands on their retirement pots. Freed from the obligation of compulsory annuity purchase, it is expected that up to £12 billion of pension savings will be looking for an alternative home as a result of pensions flexibility reforms.
Annuity sales have already dropped to a fraction of what they were – to 68,000 in the second half of 2014 from 191,000 in the same period of the previous year, according to the Association of British Insurers.
Not all of this £12 billion of cash will be accessible on 6 April – but a sizable chunk will. Hargreaves Lansdown estimates that 400,000 investors will be able to draw down their money should they want to on the first day of the new tax year, with a total value of around £5 billion.
While recent reports suggest that some pension providers are ill prepared for the April deadline, others have leaped into action – launching new products and dusting off old ones to market as the only viable alternative to annuities for the savvy investors’ retirement.
Providers Aegon, Axa, MetLife, MGM and Prudential, among others, are offering ‘third way’ products – retirement solutions for investors who do not wish to purchase an annuity or exercise income drawdown.
While coming with security of income, these products strive to offer one key element that annuities do not – capital growth. There is usually a promise of a minimum guaranteed income or lump-sum payment but this can come at a cost. In order to deliver on their guarantees, these products have to enlist the help of more complex investment strategies such as derivatives, which can often mean a higher fee for the investor.
Research conducted by Aegon found that 70 per cent of people want income certainty in retirement, so the insurer has reacted by offering unit-linked guarantees that provide a fixed income as well as access to their cash.
Aegon managing director David Macmillan says: “Much has been written about the potential for growth of unit-linked guarantees and drawdown as separate services. But Aegon believes that combining the two to manage income will be attractive for customers looking for a better blend of security and flexibility.”
He continues: “The ability to combine true lifetime income guarantees with drawdown on platform will provide customers and their advisers with the certainty of income they tell us they want but also with a huge amount of flexibility both in terms of income and in terms of their ability to switch between products.”
Axa Wealth is offering a similar service, with a guaranteed minimum retirement income with the potential for income growth and access to drawdown. Other providers are using the much maligned – in some cases unfairly – with-profits structure. The Income Choice Annuity from Prudential is an investment-linked annuity that is invested in the Pru’s £76 billion with-profits fund. The income fluctuates annually as determined by the underlying fund’s performance but has a ‘Secure Level’ minimum and promises some inflation protection.
Despite many third-way providers claiming their solution is unique, Hargreaves Lansdown head of pensions research Tom McPhail is sceptical. “To date, no genuinely new or radical retirement income products have emerged. They may never do so. It is possible to tinker at the margins with the duration and durability of guarantees, the composition and volatility of equity portfolios and the precise mix of the various components. But it is not possible to defy gravity or to conjure up any kind of flexible, low-risk, high-return retirement income magical solution,” he says. “Conceptually, they make a lot of sense and we know that most investors want some guarantees and some flexibility and reduced market risk. The problem hitherto has been to bundle that all up into one product that doesn’t then become either expensive or complicated or both.”
Of the products out there, McPhail says Prudential’s with-profits annuity and MetLife’s variable annuity have “given it a good shot”. He believes investors are better off taking a portfolio approach – tailoring a number of different solutions to their needs, such as using a conventional annuity for the secure income and a drawdown for flexibility and market exposure.
JLT Wealth Management managing director Karen McCaffrey says the difficulty for investors is that the products are not easily comparable. “Each provider will want to offer something slightly different,” she warns. “The consumer needs to know what is being guaranteed and what is at risk. Advisers will need to help consumers work out what risk they can afford to take with what will be for many their only source of income other than the state pension.”
McCaffrey says the onus will be on advisers to explain the vital features to their clients.
“Such products could be right for some people but they need to understand the implications. With the basic regulatory requirement to be clear and transparent in mind, the advising community will need to ensure this obligation is met by providers as well. She adds: “There is no such thing as a free lunch; costs will be higher but sometimes you need to pay a bit more to get the right outcome for you.”
Consultancy The Lang Cat founder Mark Polson says the chief concern for investors looking at third-way products is the use of the word ‘guarantee’. He says: “I remain unconvinced – not because the idea of a guaranteed or semi-guaranteed product is bad but because the guarantees available are usually tremendously bad value.
“Providers will say that if you ask 100 investors if they want guaranteed limits to downside and availability of growth, pretty much 100 of them will say yes. But how many of these exercises that providers like to quote bring in the considerable cost of the complex products needed to provide guarantees?”
Polson acknowledges that most advisers are aware of the pitfalls and says providers must be willing to lift the bonnet and allow advisers to perform comprehensive due diligence on the structures themselves.
“Guarantees tend to be highly complex, filled with conditions and hard to compare. I see nothing in the new pension rules that makes them more attractive than before; this has more to do with the derivatives available in the market than with the regulatory environment,” he says. “The closer we get to something that a client might genuinely understand as worthy of the g-word, the closer we come to – you guessed it – an annuity.”
Asset managers directly target post-retirement investors
Many asset managers are focused on educating those approaching retirement with regard to the suitability of their existing products.
Both Henderson and BlackRock have promised a renewed focus on making their retail offerings solution-led – suggesting income products already on the market as alternatives to annuities.
BlackRock head of UK retail Tony Stenning says annuities do not deliver value and he believes it is the responsibility of asset managers to help people through the point of retirement and beyond.
“It has taken the investment industry a long time to get to this point and realise that people invest for an event rather than to annually beat an index,” he says.
“Part of the evolution has been regulatory – Ucits measures now allow you to utilise derivatives and use cash as an active allocation.
“As an industry, we are constantly developing new strategies. I think in time we will see long-only funds become less prevalent, especially in this post-retirement space where capital preservation is key.”
In January, BlackRock relaunched its Multi-Asset Income fund, aiming to offer investors a target income of between 4 and 6 per cent, plus capital growth over the medium term. A month later the asset manager took over the management of the former British Assets investment trust, changing the mandate to a similar global, multi-asset income offering. The timing of these strategies – three months before thousands of retail investors look for an alternative to annuities – is no coincidence.
Architas, the investment arm of Axa Wealth, has also got in on the act, launching a Diversified Global Income fund specifically targeted at investors approaching or in retirement. The fund uses a blend of equities, bonds, cash and – crucially – alternatives such as infrastructure investments to provide what Architas is billing in part as a ‘Government-backed income’.
Architas chief investment officer Caspar Rock says that while annuities are the only investment product that guarantees a fixed income, they also guarantee 100 per cent capital erosion – where a multi-asset income portfolio can offer income and capital growth, albeit with an element of risk.
Stenning acknowledges the opportunity that pensions freedom gives to both asset managers and the advice industry to revolutionise investors’ income in retirement.
“The fact that people can get their hands on their cash at a later date will hopefully make them save more,” he says. “The illusion of access is a big incentive. If the investment industry gets this wrong, then we deserve the backlash.”