Blended retirement illustrations are coming by next April, but will the increased complexity make these documents impossible to understand?

27 October 2014

By Natanje Holt, Managing Director, Dunstan Thomas

The pensions illustrations regime has been progressively rationalised and simplified to a point where it is finally comprehensible to most policy-holders. Key Features Illustrations (KFIs) issued on purchase of pension plans and existing annual review statements called Statutory Money Purchase Illustrations (SMPIs), have rallied around three core areas of disclosure:

• Existing and Final Fund values (assuming levels of contributions defined)
• Value of income at retirement date (i.e. annuity value)
• Projected growth rates and Effect of Charges on that growth

However, it was all change from 6th April this year when new projection rates and inflation-adjusted rates went live, increasing the projection rate spread and reducing rates by 2.5% for inflation (taking them to -0.5, 2.5% and 5.5% respectively right now). This change did not immediately affect Drawdown illustrations.
The next set of changes to pensions illustrations will be far more significant now that, on 6th April 2015, annuity purchase at-retirement will cease to be the default option. The expectation amongst providers, from our own research conducted over last summer, is that annuity sales could halve overnight when their purchase becomes voluntary and the impact across the industry this year has been significant.

In Australia, where annuity purchase has been voluntary for some years, only 5% of new retirees still purchase one and Australia is in fact looking at how to encourage more people to secure an income through an annuity purchase. Understandably UK providers are moving fast to plug this imminent revenue gap. There are a number of product innovations happening across the market. One is in offering products with a guaranteed element to give policyholders either the ‘income security’ or the ‘capital security’ - depending on what the potential retiree (that are now unlikely to purchase an annuity) values.

This raises the awkward question: how will these guaranteed benefits be illustrated on KFIs and SMPIs? We are already being asked by providers to come up with neat ways of describing and illustrating some of these brand new retirement solutions. The resulting illustrations that pension policyholders will see post 6th April 2015 might be even more complicated and lengthy than they are today.

Guarantees will come in many forms and there will be a cost for a guarantee, so policyholders will need to read the small print carefully. The only question is how much of this print will be on the illustrations themselves. Some providers are just offering a capital guarantee that policyholders will not lose any of the value of their original investment. Others are going much further to offer a guaranteed level of income paid when decumulation begins. Some will offer guaranteed death benefit also. Others are even offering guaranteed growth percentages, albeit with growth rates which may fail to beat inflation.

However, offering all these guarantees also means communicating them effectively. That means a lot more underlying calculations, words and explanation in KFIs and SMPIs. They will need to illustrate what any new guaranteed income investment funds, sometimes called ‘Secure Income’ elements, will deliver in terms of income.
The simple drawdown illustration options going forward could become rather complex when you get into the detail as there will need to be space to illustrate the following possibly in one illustration:
1. Income drawdown from non-guaranteed funds
2. Income drawdown from income guaranteed funds
3. Income from annuities
4. Growth from unvested elements including capital guarantees
5. The impact of additional contributions to the various limits
Each element in the section above will require its own funds or portfolio. Each fund or portfolio will require different growth rates as they will stand as independent elements within the whole. Although these may be complex to illustrate altogether there is a clear benefit to the client from doing so.

The SMPI won’t escape change either. If annuity purchase is no longer the default then what key measure should the customer track to gauge progress towards an income in retirement? A final fund value would simply not be enough to inform the client of a potential shortfall in desired retirement income.

In summary, illustrations are becoming more complex. However amidst this increased complexity it remains critical that clients can still see all the benefits, risks and costs associated with each potential investment option. They must be able to value potential streams of retirement income and use this information to plan ahead or take further advice. We continue to work hard alongside our clients to ensure delivery in line with these goals ahead of the April 2015 deadline.

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