Scottish Widows has changed the default investment strategy of its group personal pension plan clients to target flexible access drawdown instead of an annuity, as member demand continues to shift away from guaranteed income.
Twice as many defined contribution pots are now moving into drawdown, according to the Financial Conduct Authority’s Retirement Outcomes Review in July, whereas 90 per cent of pots were used to buy an annuity before the introduction of freedom and choice.
Scottish Widows explained that the change to its “balanced” investment strategy, which previously derisked towards annuity purchase when members are five years from retirement, was due to a shift in the choices being made at retirement.
Pete Glancy, head of policy development at the life company, said: “A minority of people are nowadays choosing to purchase an annuity, and the majority are accessing some of their pension but leaving the rest invested.”
I can absolutely see a resurgence in some sort of guaranteed income
Richard Birkin, KPMG
He added: “To ensure we can best service the changes in behaviour that we were seeing – both from our own customers and across the industry – we have revised our default funds strategy with the intention of allowing customers to leave their savings invested for longer to benefit from additional investment growth during that period.”
Letters sent to members about the change included guidance on the four different options available to members, and offered the choice to opt out of the change.
Those customers who are already less than five years from retirement will have the option to make the change, but will not automatically be reallocated so as not to disturb their retirement plans.
Switch is a sign of the times
Experts said that targeting flexible access is now the most commonplace strategy employed by providers of DC defaults.
“[Scottish Widows] are probably a bit late to be honest,” said Andy Cheseldine, a client director at trustee company Capital Cranfield, adding that the timing of such moves was often dictated by the maturity of a provider or scheme’s DC assets.
In addition to the mounting evidence that savers prefer cash lump sums and drawdown products to buying an annuity, Cheseldine said that providers should also consider the asymmetric trade-off between targeting one or the other.
“If I’m in a default that targets annuity and I take cash, bond prices could crash and I could lose a third of my pot size,” he said.
However, he argued that a saver targeting flexible access who took annuity would not be as exposed to volatility in markets, as annuity prices are not solely driven by the bonds used to provide them.
Wide variation in investment mix
Where lifestyling towards annuity purchase involved a fairly standard mix of bonds and cash, the asset mix for defaults targeting flexible access varies more widely between providers.
A KPMG report into default strategies in 2016 found a wide variation in both the growth and glidepath phases, which differed in terms of returns generated by 10.1 per cent over a one-year period.
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Cheseldine said the key to any strategy would be to diversify, with diversified growth funds being the obvious choice for many. With-profits funds and absolute return bond funds could also prove useful, he said, providing they can address issues around transparency and the cost of active management respectively.
Don't count annuities out
However, it is possible that providers will find themselves reshuffling their allocations to enable purchase of a guaranteed income product as the DC market matures, according to experts.
“Once DC pots get to a significant size, we find that members choose more sophisticated, hybrid solutions that offer some fixed income and some flexibility,” said Richard Sweetman, senior DC consultant at Willis Towers Watson, adding that this could well take the form of an annuity.
Richard Birkin, head of KPMG’s DC solutions team, agreed: “I can absolutely see a resurgence in some sort of guaranteed income.”
Of course, the industry will have to address the perceived poor value of annuities, which has manifested itself in the increased popularity of drawdown and arguably influenced the decision to implement freedom and choice.
While interest rates are largely out of the industry’s control, Birkin said that introducing greater flexibility into offerings involving annuities might help to revive the product.
“That could be the ability to use some of the pot in a flexi-access way, whilst some of the pot goes towards purchasing a deferred annuity,” he suggested.
