Welcome to the decade of change. George Osborne set the scene in March’s Budget – and in case there was any doubt as to whose responsibility the pensions gap now is, last month pensions minister Steve Webb confirmed that the pensions industry should be ready for a decade of innovation.
“On products innovation, my hunch is that people will enjoy the new freedoms by taking some cash – a few thousand pounds is a lot of money and they will be able to do something that gives them a lot of satisfaction such as take a trip or give it to the grand children. It will be different for every person,” Webb said.
“The vast majority of people need the money to live off so for the foreseeable future most people won’t actually have a huge amount of choice – they will need the money there and then. They may take an annuity a bit later and it could be more flexible. I think this will evolve as DC pots grow so while some are talking about innovation next April, we face a decade of innovation to be honest.”
So what comes next? Now that the mainstream media seems to have declared annuities as evil incarnate what options remain?
One option on the table is structured products. Oh the irony. It wasn’t that long ago that structured products were the byword for all that was wrong with financial services. Like Equitable Life and subprime mortgages, for those pension savers who read the pink pages structured products conjure up memories of broken promises and mis-sold solutions.
In 2011, the then Financial Services Authority introduced guidance for structured product providers after it concluded that they were focusing too much on commercial interests and not enough on the end investor. Seven of the largest providers of structured products, responsible for half the industry at the time were investigated and the FSA decreed: “A lack of robustness in a firms’ product development and marketing processes can increase the risk of poorly-designed products and lead to mis-selling.”
While there’s no doubt some structured products failed to deliver for a number of investors, it would be short sighted to tar the lot with the same brush.
Morningstar chief investment officer Daniel Needham says that now compulsory annuity purchasing has been scrapped individuals will need a blend of retirement solutions, with certainty of return attractive to investors.
“Each person has unique needs and preferences, and one size rarely fits all. In a well-balanced retirement portfolios lifetime annuities and lifetime guaranteed income products can play a role, just not the only role. Combining guaranteed products and traditional assets into long-term retirement portfolios can allow individuals balance the need for lifetime inflation protected income and the ability access one’s savings for unexpected changes in people’s circumstances. Moving away from compulsory annuitisation will provide individual’s with an improved opportunity set to plan for their future, with the flexibility to take advantage of other assets and products and avoid locking into very low interest rate on lifetime income streams,” he said.
And on the whole, pension providers agree. Although they admit it would be near on impossible – and foolhardy – to come up with a quick fix for the post-annuities pensions conundrum, innovation has begun.
The People’s Pension says that it is now the role of trustees and pension providers to ensure there is a range of appropriate options for savers, but warns that people will need appropriate signposting. Director of policy and market engagement Darren Philp said that the guidance guarantee had a crucial role to play, including signposting people, where appropriate, to further advice.
Nest chief investment officer Mark Fawcett said that to date alternatives to buying an annuity at retirement simply haven’t existed for most people, but March’s Budget opens creates the possibility of making different choices.
“The market needs to innovate to ensure there are suitable solutions available,” he said. “Our over-riding concern is to act in our members’ best interests. That will be the lens through which we will consider any changes that may be needed and we are planning to launch a consultation shortly to ensure that we bring the best ideas to bear on delivering appropriate solutions to our members.”
There is also the question of who will provide the blended retirement solutions. Will it be up to the individual to splice together part annuitisation with an income providing equities fund here and a structured product there? If so will the banks go back to selling structured products?
Barclays Corporate & Employer Solutions head of DC investment consulting Lydia Fearn says that while structured products will definitely feature as one of the multiple alternatives for consideration, care needs to be taken when it comes to deployment.
“Despite the recent pensions freedom that has been introduced, the options available to pension holders has and will continue to broaden, crowding choice and selection. Trustees, providers, advisers and the introduction of the guidance guarantee all have a duty of care over how they engage the mass market and the FCA needs to guide and monitor developments,” she said.
AllianceBernstein head of pension strategies David Hutchins believes that for many pension savers this debate will simply not apply.
“Our experience of the DC market is that most savers will look to whatever is the easiest option for them, and this will form a default strategy for most members going forward,” he predicts.
“For those with smaller fund sizes this has historically been an annuity, because of the way providers have structured the options. Those individuals who were either more knowledgeable or had sufficient wealth already had access to a large range of suitable options from alternative providers, be it income drawdown or so called third way annuity products.”
Structuredproductreview.com founder Ian Lowes predicts a greater role for structured products, but thinks it should be through the advised channel. He says: “I do not think that all of the cash that previously went into annuities will now be up for grabs by other products. A lot of people will simply stay invested in equities. This may well have an effect on markets, as a significant amount will stay invested.
“But structured products can be used as part of a well-diversified portfolio, in retirement or while you are working, and I think it makes sense that those looking for alternative retirement solutions consider them.
“I have not heard of any specific products being launched for the post retirement space but I can see providers replicating existing products and packaging for this audience.
“Although I think structured products are suitable for the masses I do think that ideally they should come recommended by an independent adviser as they can take a whole of market approach whereas a bank will simply peddle their product which may be unsuitable.”
For the remainder of pensioners Hutchins expects the predominant behaviour of most individuals with smaller funds will be to do what is easiest and take their entire savings as cash as and when they need it to spend, which may not be immediately on retirement.
“For those who leave it invested in the plan beyond retirement, most will be in the default investment strategy,” he says.
Within the City, structured products are already being used to assist capital preservation. Defined benefit schemes use the products and the underlying instruments that support them in order to protect the scheme from changes in interest or inflation rates.
As to whether they will be suitable for DC schemes Fearn thinks there needs to be considerable more work done before implementation.
“Such investments may be more widely used in the DC market over time, however there are costs and risks involved by using this type of investment which will need to be clearly understood by those who govern the schemes,” she said.
UK Structured Product Association chairman Zak de Mariveles says: “It is not unreasonable to expect a significant uptick in structured product sales to this particular market as focus increases on capital protected products and products able to give fixed guaranteed levels of income. One of the many advantages of Structured Products are that the potential returns – and risks – are predetermined at the outset, with all costs made transparent within client facing literature.”
Structured products – What are the risks?
Structured products can be designed in such a way that they protect investors’ capital while providing a high level of steady annual returns. While they are not guaranteed as an annuity is, many structured products are billed as such.
They use derivatives such as futures to help hit these targets, agreeing to buy or sell a specific quantity of a specific asset at a fixed future price on a fixed future delivery date. They can hedge the long holding decisions they make in this way. However, this agreement relies on the counterparty delivering their end of the bargain – if this counterparty gets into financial difficulty and is declared bankrupt the structured product suffers.
While structured products can be risky if cleverly executed they can deliver stable returns.
Chief Executive of NOW: Pensions Morten Nilsson said that structured products could play a part in capital preservation during the glidepath phase when a DC scheme member is derisking towards retirement.
But he warned: “These products tend to be complex, and therefore before such products are adopted by schemes it is vital that Trustee Boards and IGCs have a thorough understanding of the advantages and disadvantages in order that they can assess whether they represent good value for their members.”
Derivative investment strategies are increasingly commonplace, and can extremely effective says Aegon’s Investment Director Nick Dixon, but he warns the complexities involved in using derivatives means that prudence and effective governance are vital.
Debbie Falvey, Senior DC Consultant with Aon agreed that it was not just the underlying makeup of the products themselves that posed a risk to investors, but the short timescale to implement new options which might either result in poor product design and poor value.
“Rushing to offer alternatives without proper due diligence or reluctance in some trustee bodies to consider new options from fear of future problems , could be detrimental to members,” she said.
