4th May 2011

LV= Choice of vehicle

In recent weeks, we have learned that inflation has fallen to 4%. Although many readers would view this as high, it was sufficient to give reassurance to the markets that the Bank of England would be able to resist interest rate increases in the immediate future.

This has been considered good news considering the subdued growth of the UK economy which could suffer further if interest rates rose. On the other side of the pond, Standard and Poors has warned the US that their credit rating could be cut if their growing budget deficit is not reduced.

All these pieces of news have driven investors into the UK bond markets, reducing the yields available to both private and institutional investors. As the majority of annuity providers invest funds in the corporate markets, this has reduced the amount of income it can pass on the customers and has resulted in falling annuity rates.

So is now is a good time for customers to purchase an annuity?

In reality, there are so many factors impacting on the annuity market that basing the decision purely on getting the best rate is a dangerous game.

Solvency II is likely to increase the cost of annuities in the future, but there are suggestions that the impact may not be as great as originally feared, particularly for those composite insurers who can hedge the longevity risk against their term business. Similarly, the full impact of Test Achats is yet to be seen, but it’s likely to result in marginally lower rates for males, but much better rates for females.

Then there are economic and investment conditions. Let’s face it, if you know where interest rates or bond yields are likely to be in 12 months time, then you have the potential to get very rich.

So I’d suggest that the annuity purchase decision should be driven by individual customer profiling – when does the customer need to receive a fixed income for the rest of their life, what is their risk appetite and  are their needs and circumstances likely to change in the future?

It is important to assess both the benefits and risks of deferral if that’s the plan.  Annuity rates have improved by around 3.5% over the last 6 months, so it’s is easy to foresee the impact of the Gender Directive and Solvency II being overtaken by economic and investment considerations. Then consider that a customer deferring annuity purchase until they qualify for an enhanced rate could well increase their income in retirement by around 20% - a strong argument for deferral if the customer can accept the risk of doing so.

Then thoughts turn to the deferral vehicle. Some customers will not have the appetite for the full flexibility or complexity offered by Drawdown, so the ‘breathing space’ provided by a fixed term annuity style product could be the perfect solution for someone looking to retire but defer locking into a lifetime annuity.

These products give customers the benefit of a secure income for a fixed term, but with the full flexibility to purchase an annuity, transfer to Drawdown or purchase another fixed term annuity at the end of the term.

The beauty of the fixed term annuity is that customers do not have to decide on the shape of their eventual annuity purchase until they come to buy it. This means adjusting their client’s income shape and level to suit them.

If a customer requires income higher than the GAD maximum, then LV= offers a Flexible Drawdown option which allows customer unrestricted income, provided it is sustainable over the term of the plan, allowing advisers to develop an integrated income and investment strategy

We are seeing a lot of innovation in the fixed term annuity market at the moment, and we are expecting a number of new entrants into the market over the coming months. Advisers need to be comfortable ensuring that they recommend the best annuity deferral vehicle for their clients, and this is definitely a part of the market that they need to keep abreast of.

Investments