TPAS, annuities and the variable quality of advice

There are many good IFA firms. Some are not so good. Yet, there is a solidarity in adviser world that results in any criticism being trashed as wrong, biased, provider based etc, etc. Criticism is good and right. If bad practice is not criticized, it is tolerated and that is iniquitous, especially for customers.

As a judge of numerous awards, I see stuff that would make the regulator cringe. In my work as a research consultant, I hear stuff that I am reluctant to write down. Good IFAs must recognise that the client has little way of differentiating the good from the bad. Thus, they have an interest in condemning bad practice.

The changes on pensions maturities announced in the budget are proving highly contentious, with strong opinions for and against. The Government has promised all retirees face-to-face guidance (initially advice, bit subsequently changed to guidance).

I am of the view that such initial guidance should be offered by an organisation that does not benefit from the outcomes, excluding both providers and advisers. Both have too much skin in the game. An organisation such as TPAS already conducts some 80,000 interviews annually and could gear up to handle the lot as long as it is accepted that face-to-face is neither wanted or needed on most instances. Before advisers jump up and down with rage, please note that TPAS will pass appropriate enquiries to them, which will, by definition, be warm and suitable.

The question for me is, how many advisers are fit to receive such enquiries? To illustrate my concern, let me use as an example, the case of a recommendation by an adviser in the Weekend FT’s Money section – not the Sun or the Sport, but the FT. The adviser, who I will not name here, says, “If you want to avoid an annuity – and frankly who wouldn’t since they are such poor value, you could construct a portfolio of gilts and bonds, which are far more flexible and give similar returns to residential property.” The money involved is £150,000.

He seems to be suggesting that a reader does this himself, or perhaps an adviser does so with a friendly stockbroker. Why is such advice wrong? Well …………….

  • Almost everyone in investment world agrees gilts yields are at the bottom and only have one way to go.

When QE ends and interest rates rise, there will be some nasty pain. Bond yields increased dramatically last year on the suggestion of tapering of QE.

In short, Gilts and bonds are most certainly not low-risk. Our client could catch a horrid cold, ​from which he would never recover.

  • Our adviser seems unaware of the impact of mortality drag.

​In the words of annuity expert, William Burrows:

​’Drawdown results in the deferral of annuity purchase and so the investor does not benefit ​from the mortality cross subsidy. This means that in order for a drawdown fund to provide ​the same income as an annuity there has to be an extra investment return each year to ​compensate for the absence of this subsidy.’

​Our adviser’s portfolio is hardly going to meet the return requirements – quite the reverse.

  • Longevity risk

​Our adviser’s portfolio of Gilts and bonds will enjoy low income and might well suffer serious ​capital loss. The client will have to withdraw capital for any sort of reasonable income. What ​happens if the capital is exhausted before he dies? The adviser will be long gone! Annuities ​may appear to represent poor value, but they are the only game in town when it comes to ​insuring against longevity.

  • Investment cost

​Our adviser recommends creating a portfolio of Gilts and bonds for £150k. Does he not ​realise how expensive this would be? In dealing costs and time costs, it would be way out of ​court. Moreover, does he have the expertise to choose the right stocks? Of course, not.

Personally, I believe that an annuity will be the default option for the majority who are healthy. I believe that some underwriting process will be necessary for all. There are legitimate ways to continue to invest and postpone buying an annuity, as long as mortality drag is understood, so that an appropriate investment strategy is adopted to generate an adequate return.

Unless the client has enough assets that provide income on which he can happily live without resort to capital, longevity insurance is required. Such cases will be in the minority.

I am afraid the only way to avoid a mis-selling scandal is to introduce a qualification similar to G60 that ensures advisers conducting this class of business know the basic rules and have adequate expertise in taxation, investment, mortality drag and longevity.

It is a coincidence that talk of a 15-year longstop on adviser liability has occurred now. In most cases, more than 15 years will have elapsed before clients realises that they received poor advice!

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10 thoughts on “TPAS, annuities and the variable quality of advice

  • So by implication you are suggesting that annuities are suitable for the majority. I’m afraid I simply can’t agree and I do understand mortality drag and longevity risk.

    You are focusing on one aspect of a clients objectives ie income and implying that for most having to draw on the capital is a bad thing. You seem to forget that the pension fund actually belongs to the client and under current pre budget rules the system of drawdown or annuity a system designed specifically to prevent clients EVER being able to deplete this pot. Most clients feel cheated and bitter at this point, more so once death benefits have been explained.

    There is absolutely no problem in my eyes with helping a client withdraw as much as they can from their pensions provided it it is done in a way which mitigates all forms of tax, meets the clients objectives and most importantly, with the clients informed consent and understanding that once it has gone it can’t be replaced. The government’s budget changes are a triumph for.common sense and personal accountability.

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  • Completely agree. Completely. The “engine” of the drawdown is very rarely considered and is the most important facet of the advice. Without a well managed portfolio, all the planning in the world is for naught.

    This is not a fashionable view however as most require some sort of spreadsheet thingy to throw up nice pictures so that the truth can be set free, or some other pish.

    Good piece Clive; I got your back.

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  • Why don’t we hear more from people complaining about having funded “mortality drag”? They never seem to say anything.

    Annuities are poor value because insurance companies make such massive profits from them. Why did insurance companies profits fall after the budget?

    Life expectancy for a 65 year old male is 21 years.
    21 year gilt redemption yield 3.4%
    Best annuity rate 6%.
    How much can longevity insurance cost?

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  • It is fair to say that virtually all pensions were set up for income. However, you are right to question whether that is the sole motive now that there is an option.

    I can see considerable risks in facilitating withdrawal of capital to the extent that income is insufficient to achieve short and long terms needs and objectives.

    My major concern is where the client outlives the money and blames the adviser. Me feeling is that the adviser should strongly recommend ensuring adequate income whilst also insuring against longevity.

    If clients wish to make peculiar or unwise decisions, so be it. However, advisers must be seen to have given sound advice.

    The example I quoted from the FT was not sound advice. You have not commented on this, which was the main point of my rant!

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  • I havent seen the advice but cant comment properly. But the fact that you and your mates think that gilts and bonds are the same thing doesnt mean that the advice is not sound. High yield bonds, emerging market bonds, RMBS etc can all generate high returns for a client.
    “When interest rates rise”. What were Japanese advisers saying back in 2000?
    The adviser may be unaware of mortality drag, but he does seem aware of the effect of insurance company profiteering. Why dont insurance companies have to set out the effect of charges for annuities? The fact that they dont doesnt mean that there arent any charges. A portfolio of gilts and bonds will probably have lower charges than the hidden charges in an annuity.
    We shouldnt try to standardise advice and opinion. As long as the adviser made his point clearly, and set down the risks, then the advice is sound.

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  • Why do we do this navel gazing ?

    However you look at it the Budget has provided a fantastic opportunity to talk to people – clients or otherwise – about their financial arrangements for their later lives.

    Coupled with auto enrollement we now have a pretty unique atmosphere around savings and used properly it is wonderful opportunity to create new business or to increment existing arrangements.

    Instead of focussing on what might be going wrong why not share our success from these changes ?

    Who has used the Budget or AE to create new relationships, cement existing ones and perhaps most important has made real money as a consequence.

    I for one would rather hear of other peoples good news than dwell on what will always inevitably be opportunism from a few bad eggs.

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  • Phillip
    Can you clarify what you mean by ‘me and my mates? I can assure you that I do have a pretty workable understanding of government and corporate bonds.
    All experts agree that there is a capital risk here as interest rates are near zero. Quite simply, it is bad advice. You end by saying, “As long as the adviser made his point clearly, and set down the risks, then the advice is sound.” This is not the case. Neither regulator nor PI insurer would accept that.The advice must be sound. Whilst I do not like standardisation, there are some situations where there is very little room to move.
    I have had a number of discussions with various clever folk on alternative solutions. All have struggled for a suitable portfolio. To beat the critical yield, a high equity portfolio is required, but that is risky too. My expert on FI mate says, “floating rate credit while rates normalise – then gilts or annuity in 6 years time or so. Win win?” He may well be right. If you send me your contact details, I can let you have some slides that might be useful.

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  • By “you or your mates”, I meant the same group of people as you refer to as “all experts”. You havent defined “expert”, and I doubt whether you will know “all experts”, or what they are thinking. What evidence do you have to show that the predictions of “all experts” turn out to be correct?

    Insurance companies make a lot of money out of the hidden charges in annuiities – one logical option for clients is to self insure against longevity risk rather than filling the coffers of insurance companies by paying the hidden charge in annuities.

    You might not agree with the advice, but that does not make it wrong. It is also not right to persecute the adviser for having opinions which you disagree with.

    by the way, I wasnt the adviser! And I wouldnt have recommended this solution.

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  • Philip

    I don’t think I referred to experts in my original piece, but no matter. I chair The Investment Network as well as running a research business in retail investment. I regular discuss difficult and important issues with senior people in asset managers, life cos, distributors etc, etc – people who understand complex issues and who are looking for suitable solutions.

    The view on Gilts is not an opinion. It is a fact that interest rates are at an absolute low; it is a fact that QE means Gilts/Treasuries are being purchased for other than market reasons; it is a fact that regulation means Gilts are being purchased by banks and insurers for other than market reasons.

    This Gilt yields ARE very low; Gilt values ARE very high. QE will start to be tapered soon, meaning Gilts and bonds will fall. Gilts and most bonds are NOT suitable for a pension drawdown fund right now.

    In this case, such advice was quite simply wrong. As a regulator said to me only yesterday, “We need to know what good and bad looks like (in retirement portfolios).” I agree. Good is hard to define in today’s peculiar market. A portfolio of Gilts and bonds in such a scenario today is not good; it is bad. That one is easy!

    On the issue of insurers making lots of money on annuities, you are no doubt right in some parts of the market. I am not sure this is the case where top rates are offered. Be good to know.

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  • Shouldn’t all of these debates be about demonstrating the benefits which come from a healthy on -going advice based relationship with a client rather than a discussion of the merits of transactional activities.

    If nothing else the last five or six years have shown us that few solutions are really durable and that we need to stay with our advice and keep it relevant as circumstances alter.

    Certainly the stance taken by the Ombudsman nowadays should be telling us all that no matter how well you think you covered your bum in your initial solution you must ensure your advice remains relevant in every possible sense.

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