Taking a variable view

Variable annuities are a growing market in the UK, but just how flexible are these ‘third way’ products which are meant to bridge the gap between income drawdown and what is effectively compulsory annuitisation from age 75.

Aegon is the latest entrant into the market, following MetLife, Hartford and Lincoln, with its ‘Income for Life’ retirement solution which targets individuals between 55 and 75 with more than £50,000 of savings.

It offers investors a “guaranteed income for life” regardless of the performance of the underlying investments, although if the assets achieve positive returns the product also offers an “income escalator” that “locks-in” a higher level of guaranteed income.

However the guarantees provided by these products come at a cost on top of annual fund management charges, which in Aegon’s case range between 0.5% and 1.6% depending on the choice of underlying investment fund, with in general the least risky portfolio resulting in the lowest charges.

And at a recent debate, hosted by Watson Wyatt, which provides actuarial and consulting services to the pensions industry, 43% of the senior financial services executives attending, disagreed with the suggestion that variable annuities “provide peace of mind at a fair price”.

As a result 74% believed consumers would only be willing to pay a guarantee fee of 1% or less a year, while just 8% thought a cost of 1.5% or higher would be considered “acceptable”.

In addition, 67% thought the new type of products would only be suitable for 10% of consumers, a small proportion of the retirement market which has previously been estimated at £14bn.

Hargreaves Lansdown points out that the products are also confined to a “fairly narrow fund value range” of between £50,000 and £100,000, and suggested the cost of the guarantees can be expensive and in some respects “illusory”.

The IFA firm claims investors are still exposed to a “variety of risks” including the effects of inflation and annuity conversion, particularly as Aon Consulting recently revealed that rising inflation and a 4.2% increase in the retail prices index mean pensioners could lose 20% of the value of their purchasing power in the next five years.

Helen Dowsey, principal in the benefit solutions division of Aon, says: “Existing members need to take measures to defend against such negative implications. Individuals should consider investing in asset classes that offer inflation protection to safeguard their pension pot.”

“Over long periods of time equities have tended to provide an element of inflation protection and therefore investing in equities, particularly for younger workers, should help. For those approaching retirement, the most appropriate asset class may be index-linked gilts,” she adds.

However, with the development of more flexible alternatives in the “decumulation” phase of retirement, both consultants and independent experts highlight the need for education and advice for scheme members.

“While all this extra choice is naturally good news for those reaching retirement, in practical terms it makes the decision-making for defined contribution [scheme] members that much harder,” says Adam Stevenson, a senior consultant at Watson Wyatt.

Ros Altmann, an independent pension policy expert, warns this advice and information gap could make it the next pensions “mis-selling” scandal.

“Every year, hundreds of thousands of people buy an annuity with their private pension savings. Nothing is being done to actually ensure that people know what questions they need to think about before buying their annuity.”

“This is surely a gross dereliction of duty. Getting the right annuity can make a huge difference."

2 June 2008