Friday, 24 November 2017

    Three-in-one retirement products around the corner

    In part one of our investigation into the at-retirement landscape, Charlotte Moore looks at the possible emergence of three-in-one products

    Before the introduction of the freedom and choice legislation at-retirement provision for defined contribution schemes members was straightforward – providers simply needed to provide access to the best value annuity. But now members can choose how they use their pension pots, scheme providers now have to find a suitable alternative solution.

    There are two approaches to the problem. Either the scheme ensures the member has access to a range of different products so they can pick and choose. Or the scheme works with a provider to produce an at-retirement solution which will provide an income without requiring any investment decisions.

    It’s unrealistic to assume that defaulted members will suddenly become engaged”

    Many consultants and asset managers think providing an at-retirement option is the better choice. After all, the majority of scheme members have been a member of a default scheme all their working life and have made no investment decisions.

    Tim Banks, managing director of the pensions strategy group at AB says: “It’s unrealistic to assume that defaulted members will suddenly become engaged in the investment process as the approach retirement.”

    Mark Fawcett, chief investment officer at Nest Corporation, agrees: “Members cannot be expected to take complex investment decisions that require balancing different requirements.”

    Not only do scheme advisors and designers think this is the best idea, many individual company schemes want to provide their members with a preferred solution. Debbie Falvey, DC proposition leader at Aon Employee Benefits, says: “Certain options already exist within the trustee-based scheme such as access to cash or an annuity.”

    Members cannot be expected to take complex investment decisions”

    While members will have to move their money to find an income drawdown product, trustees are doing the necessary research and due diligence to recommend specific product which they think would suit their members. Falvey says: “But there is no requirement for members to choose that product.”

    But while trustees might currently be directing their scheme members towards cash, annuity or income drawdown options, in the future there could be one at-retirement option which offers all three. Designing this product is not straightforward as it requires a number of different features which will change as the member moves further into retirement.

    multi asset

    Source: Flickr

    Such an at-retirement product should have an allocation to cash. This would give scheme members the flexibility spend more when they are more active during the early years of retirement without having to sacrifice too much income in later life.

    In the first two decades of retirement one of the key features required is flexibility. Fawcett says: “Schemes members need a regular income but with the option to draw down additional sums.”

    The product should promise to provide a certain level of income”

    The investment strategy should allow the value of the pension pot to increase. Hugh Nolan, chief actuary at JLT, says: “This is impossible to achieve without also allowing the value of the pot to fall.” However, the downside risk should be properly managed. “The product should promise to provide a certain level of income while ensuring the value does not fall below a certain threshold,” adds Nolan.

    The best way to provide this type of flexibility is to use a risk-managed multi-asset fund. “As well as having an allocation to equities, there should be around 20% allocation to fixed income,” says Nolan. This allocation to bonds would provide some protection from equity market risk as well as provide some annuity price matching.

    The other advantage of using a diversified, risk-managed multi-asset fund is that it can be used both in the run up to retirement and after retirement. Patrick O’Sullivan, director of investment consulting at Redington, says: “This provides the scheme member with the best investment outcome while they decide when they will retire and their long-term plans.”

    As expected, those members who had a pot with a value of £20,000 or less took it as cash”

    It’s also possible to embed advice within a product to help prevent a reckless income drawdown programme. Banks, says: “While members can withdraw whatever income they like from our retirement bridge product, the fund manager embeds a suggested drawdown rate.”

    There are positive signs that members respond well to these types of at-retirement products. To date their behaviour is largely determined by the size of their retirement pot. Banks says: “As expected, those members who had a pot with a value of £20,000 or less took it as cash.”

    However, around 50% of members with a pot value of £20,000 to £50,000 have chosen the drawdown income product with embedded advice. Banks says: “That proportion increases to almost 75% for those with a pot worth £50,000 to £100,000.”

    Readers' comments (1)

    • The wording in this article is too vague for such an important decision for individuals with or families who will be requiring a guaranteed lifetime indexed income, which must be provided from a capital sum, for up to 30 or more years. With regards to investment decisions, professionals must stop thinking that the information they have is too hard for non-professionals to understand. What's needed now that individuals need to make their own investment decisions is to build a communication program on 'Risk Profile' analysis Q&A and how it should be developed or designed for each individual at the start of plan membership and periodically, say every 5 years, during their Accumulation Phase. The article also gives the impression that a DC plan is only for 'old age' retirement life event when these plans must provide benefits for the other life events: disability and death. Once the main principles are defined for retirement financial and lifestyle planning, then its easy to help participants make the right choice for investments in the Accumulation Phase and guaranteed lifetime 'indexed' income in the distribution phase. Finally, the pension professional needs to advise the client on the impact of global employment opportunities on one's desired retirement income and lifestyle i.e. coordination of benefits. Looking forward to further discussion and feedback on this subject matter.

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