The story so far…no one will have to buy an annuity
In his latest Budget, George Osborne announced that nobody entering retirement from April 2015 will need to purchase an annuity. The change has been hailed as the biggest shift in pensions policy in a century. Increased competition and choice for consumers will be celebrated among consumer groups, but there are serious concerns about the potential ramifications for annuity providers.
Immediately upon the unveiling of the proposal, the share prices of some of the UK’s largest annuity providers dropped sharply. The first assumption among observers was that the announcement would have a catastrophic effect on the annuities market. The belief was that most consumers will withdraw their entire pension funds upon retirement, shunning annuities and choosing to use their money how they see fit.
The announcement doesn’t necessarily mark the end of the market for annuities. The plethora of options that will now be available to consumers will require that annuity providers rethink their products in what will be a much more competitive landscape, but the underlying appeal of a product that offers a guaranteed income for life is still strong.
Lack of competition, understanding, appeal…
Until now, annuities have been dogged by two main problems. First, consumers are put off because they seem to offer a low return compared to some other investments. This is a point of perception. If considered as an investment, then there are undoubtedly higher-yielding products to be found. However, consumers would perhaps be better off viewing annuities as a form of insurance product. For a population increasingly living into old age, the guaranteed income of an annuity throughout their retirement can be invaluable.
Second, the lack of movement from consumers, who have more often than not bought the annuity offered by their pension provider without shopping around for the best deal, has negated the need for competition to a great extent. This has created a lot of negative headlines for the market and has undermined confidence in annuity products, at the same time as increased longevity and gilt rates have placed downward pressure on annuity rates.
But not the end of the road for annuities
Despite the reputational challenges facing the annuity market, Mintel’s research shows that there is still demand among consumers for annuity-style products. A fifth of potential annuitants aged 45 and over want a straightforward product that pays a fixed income for life, which indicates that there is still a considerable market for annuities. However, this figure would still represent a huge drop in sales for the industry, and it will need to adjust to the reality of the new rules where there will no longer be a captive market for its products.
Our research shows the most important factor for those thinking about their retirement income options is the desire for flexibility, with a third (32%) of non retired Brits with a DC pension stating this. If nothing else, people will definitely have more flexibility with the new rules. New retirees will be able to buy an annuity straight away, withdraw their entire fund, withdraw portions of it as needed, buy new bonds from NS&I, or any number of other options. The difficulty for annuities providers will be finding a way to inject flexibility into a product that is essentially rigid.
One option would be to promote and further develop protected annuities. Unlike standard annuities, these policies allow the consumer to protect up to 100% of their pension pot. Should the annuity holder die before receiving payments totalling the protected amount, the difference between the amount received in retirement income and the protected amount is paid as a lump sum to a beneficiary, less tax deductions. While the annuity holder doesn’t get to spend the cash personally with his type of product, they do know that their family will benefit from their saved funds. Possibly the most immediately appealing alteration to this would be to provide a pay-out upon diagnosis of terminal or critical illness, or simply offering a way of exiting the annuity, subject to some form of penalty if the consumer has yet to receive their full pension pot.
Short of launching new, or evolved products, providers will find themselves in a position where they must simply be more effective in conveying the benefits of annuities. Forced to compete with other products, one of the best things to come from these proposals may be improvements in the marketing strategies of annuity firms.
Good advice is essential
The changes raise questions outside the life industry. Giving people freedom to make their own choices is a worthy objective, but some will inevitably make poor decisions. It is, however, too simple and pessimistic an argument to say that this move will cause a widespread frittering away of pension pots by irresponsible retirees.
Aside from the idea that most people will want to secure their financial future, the fact that 75% of the pot will be charged at a consumer’s marginal rate and could move some into the higher tax bracket will act as a deterrent. Perhaps more important than the risk of people blowing their funds on frivolous luxuries is the risk that even with the most responsible intentions, they will make unsuitable decisions on what to do with their money simply by not understanding their options.
The Government announced that every retiree will receive free, impartial advice on their retirement income options. This is an important starting point, but the value of this initiative is entirely dependent on the quality (and amount) of advice that retirees will be given. The £20 million pledged by the government is only intended to cover the cost of setting up the scheme, and wouldn’t even begin to cover the cost of providing high quality face-to-face advice to the hundreds of thousands of people who retire each year.
The role of good advice cannot be understated as consumers enter this new arena of retirement options. Mintel’s research consistently shows a lack of understanding and engagement among consumers when it comes to retirement savings. Many people simply aren’t sufficiently interested in the subject to mean that they’ll be able to take full advantage of the greater flexibility that these reforms introduce. Indeed, it is likely that advisors may be among the biggest beneficiaries of the proposals as they guide consumers through the most appropriate options.
Rich is Financial Services Analyst at Mintel and researches and writes a range of financial services reports. Prior to joining Mintel, Rich gained experience of lending and credit risk while working for HSBC.
