069 | Drawdown reviews

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  • Jan Holt, Head of Business Development Team , Just Retirement
  • Richard Sheppard, Intermediary Development Manager, MetLife

Learning outcomes:

  1. How to create a drawdown review process
  2. How to take account of longevity, mortality and inflation risks
  3. The importance of an accurate critical yield analysis

FCA discussion paper 16 01: ageing population and financial services

COBS chapter 9: suitability (including basic advice)

PIA regulatory update 55

PIA regulatory update 67

The Exposed Generation


Since pension freedom was introduced in April 2015, over £4.2 billion has been invested into 63,600 drawdown contracts. So that’s an average drawdown of around about £60,000. Learning outcomes 1. How to create a drawdown review process 2. How to take account of longevity, morality and inflation risks 3. The importance of an accurate critical yield analysis Tutors on the panel are: Jan Holt, head of Business Development team , Just Retirement Richard Shepphard, Intermediary Development Manager, Metlife PRESENTER: In this learning module on Akademia, we’re going to be looking at drawdown reviews in the light of recent pension freedoms. Our tutors are Jan Holt of Just Retirement and Richard Sheppard of MetLife. So let’s run through what they’re going to be covering. First of all Jan Holt is going to discuss the reasons why clients might choose drawdown, regulatory guidance supporting the review and then the creation of a drawdown review process. After that Richard Sheppard will look at the advice process in light of the FCA’s recent discussion paper 1601 on an ageing population and financial services. He’s going to be covering how to build an advice proposition around client expectations and balancing certainty of income with future flexibility. After this I bring Jan Holt and Richard Sheppard together in the Akademia studio to talk through the practical implications of their initial presentations. And we’re going to be covering the future role of annuities, the changing nature of drawdown advice as clients age, including the client’s family in the advice process; then we’re going to look at the impact of inflation and longevity on the retirement strategy, critical yield analysis and the drawdown review. Then managing and meeting clients’ income expectations; then it’s going to be looking at ensuring that the correct death benefits are in place for clients; and finally how to help clients understand concepts such as mortality drag. But first of all let’s join Jan Holt. JAN HOLT: Since pension freedom was introduced in April 2015, over £4.2 billion has been invested into 63,600 drawdown contracts. So that’s an average drawdown of around about £60,000. And of course don’t forget many people were already invested in capped drawdown or flexible drawdown prior to the freedoms. So let’s think about the reasons why clients would choose to use drawdown as opposed to the alternatives. So if we think about the traditional drawdown client, then he or she would be using drawdown for a number of reasons. So for example they could be looking for complete control over the capital, for flexibility in terms of the way in which they take income from their arrangement, or of course in order to be able to pass on pension benefits to beneficiaries or dependents. However since pension freedoms there’s clear evidence of a new breed of drawdown clients emerging, so what you might call the ZIDs, or the zero income drawdown clients. So these clients are actually choosing to use drawdown to facilitate a release of tax-free cash, and then the remaining money actually sits in drawdown as a holding vehicle until they ultimately make some future decisions about their income. But for now they’re in this kind of holding pattern and there’s no intention to draw any income from the plan at the moment. So let’s not forget that capped drawdown still exists for those people who designated funds prior to April 2015. So it’s important that those in capped drawdown will continue to receive a regular review of their income to make sure that it doesn’t exceed HMRC limits. So in other words providers will have to continue with the GAD review. And that will be done on a triannual basis for those under 75, and on an annual basis once the client reaches age 75. Regardless of why people are in drawdown, or what type of drawdown arrangement they’re in, it’s absolutely vital that everybody has a good drawdown review. So there is a lack of regulatory guidance on the drawdown review process itself, but what we do know is that where a review takes place then there will be an outcome to that review, so whether that’s nothing needs to change, right through to well we need to make some clear changes to the plan that you have. So that outcome constitutes a personal recommendation, and therefore what we can do is we can revisit COBS 933, which is the set of guidance that the regulator recommends when first placing a client into pension drawdown. It’s also useful to take into account regulatory updates 55 and 67. So although they might seem a little outdated having been released by the PIA, it’s still worth a look because RU55 takes into account the use of critical yield in drawdown, and RU67 gives some good guidance following regulatory review of clients in drawdown. So we can look at the requirements of COBS 933 here, and the regulator here is giving information on what should be taken into account when making a recommendation to somebody to use drawdown. And there are some very obvious things within this guidance, such as the client’s attitude to risk, and maybe some less obvious things like for example the client’s state of health. So typically a drawdown review process would take into account the client’s personal situation, it would undertake a full review of the investment performance, and then finally come up with a series of actions or recommendations to be discussed with the client. So we can look at the personal circumstances first. So, one of the first things that would have to be taken into consideration was the client’s income. So if they haven’t been taking income do they now need to switch that on? Or if they’re already taking income is that income appropriate and sufficient to meet the client’s needs? And of course in order to establish the levels of income required, it’s also useful if the client understands their personal minimum income requirement, so the PMIR as we call it, which means essentially what level of income do they need to meet their core expenditure? And then considering how that personal minimum income is actually going to be delivered? So would that be through income drawdown, or would it be through other forms of guaranteed income, like state pensions, like defined benefits, or guaranteed income for life from an annuity? Or would other assets be actually used to generate some or all of the client’s income? Also in terms of the client’s personal situation an exploration of their attitude to risk is useful, particularly as there is a tendency for that to change as people go through retirement and into later life. An adviser would also need to establish whether capacity for loss exists. And then finally take into consideration the client’s health and the client’s likely life expectancy. And also discuss with the client that they understand that being in drawdown means that they take on the burden of longevity risk rather than pass that on to an insurer. So moving on to the investment review, this is a crucial part of any drawdown review, and one of the key things that needs to be looked at is whether income can continue to be delivered in a sustainable manner. So another important part of this is to work out an appropriate critical yield for the client, and to understand the income benchmark that actually is being used to calculate that critical yield. Has the client’s health been factored into that? Does the client need to draw any further lump sums and are there any tax implications to this approach? And clearly whether the portfolio is performing in line with requirements or expectations. Does the strategy need to change? And whether the client’s actually targeting a specific growth objective or whether they’re in that holding pattern that we talked about earlier. It’s also useful to establish a plan B for the client if the fund value were to fall significantly. It’s important to look at the economic conditions, so for example the market outlook for investment returns, interest rates and rates on guaranteed income for life solutions. And finally ensuring that the client is aware of the amount of equity exposure they’ve got, and the impact of any volatility on the timing of their decisions to make changes like drawing income or taking further lump sums. And then the final part of the drawdown review would be to discuss and document all of the action points and take them forward with the client. So the drawdown review is absolutely crucial in helping to manage a client’s retirement resources throughout their lifetime. It’s also useful for firms if they haven’t already to maybe take stock of their own review process to make sure that it’s kept pace with all of the change that we’ve seen in recent years. RICHARD SHEPPARD: Well it’s quite interesting that as providers there’s been a lot of talk and focus on longevity, the fact that people are living longer. And that message is becoming well heard, certainly well listened to, but probably turning into a bit of white noise. The regulator has enhanced this discussion recently by publishing a discussion paper on how you deal with the ageing population. And what you have there with an ageing population is people’s requirements change. Their requirements change, their attitudes change, and in some circumstances their expectations change. And it’s interesting the regulator said a number of years ago that it’s the outcome that people most expect is the one that they want. And as a consequence once you understand what clients are expecting as they age, you can then build a proposition around that. And we looked at this with our research, the research that we published early this year, and it was around the Exposed Generation. Looking at people from 45 right the way through the age range. And we covered not just their thoughts and their views in this post pensions freedom world, but we also looked at what they’re expecting in retirement. Well it’s quite interesting as part of the research we drilled down to what their financial expectations were, and then we looked at their expectations in day-to-day life. So the first one was around 37% of the respondents – it’s interesting that the research answers don’t total 100%; that’s the methodology that sits behind it. But the top answer that came out was unexpected or unanticipated health or care costs. It is a consideration. As people age they are probably feeling the pressure from friends, from the media, and the expectation that as they age their needs will change and they’ll have to start to fund it themselves. As we move to some of the other interesting statistics that came out through our research, around 5% of individuals are expecting to get divorced in their later life as they approach and enter into retirement. Now, as sad as that sounds, the reality is actually higher than 5%. Around one in two experience divorce as they enter retirement: the phrase ‘silver splitter’ now starting to be used to describe an unfortunate and growing number of individuals within the UK society. Another one which is again is probably an accepted reality, and that is one in three, just short of one in three are expecting to financially have to bail out their kids. That’s the reality. Many of us will know of people that are in that circumstance either as the receiver or as the deliverer of that bailing out process. But where is that in the financial plan process? What assets does the client hold if they are bailing out their children? What liquid assets have they got that are available to do so? And there’s another one in here as well, which is an unexpected tax bill of £5,000 or more. There are a number, just short of 10% expecting an unexpected tax bill. Well where on earth is an unexpected tax bill going to arrive from? Well it could be down to the changes in the tax process of say deposit accounts and gross interest, or dividends on shares that are now coming into play in the tax year 2016/17. Which clients will maybe not be as prepared as they expect. So the relationship in terms of what people are actually doing when it comes to purchasing or making the decision for annuity versus drawdown in the post pensions freedom world, that is key and pivotal, because the expectation in an ageing individual happens much further down the line. The decision is being made today, tomorrow around their retirement strategy. What we have experienced is clients looking for the certainty of today, but they want flexibility in the future. And if they are unable to achieve that flexibility in the future because of a decision they’ve made based on certainty today, and we are seeing at time of this interview being filmed the issues around annuity and resale of annuities being certainly discussed and consulted upon at the moment, but if somebody were to move into the annuity market with their pension fund, are they going to be able to make an alternative decision, change their mind, embrace flexibility at a later point should they wish to pay for care, should they wish to bail their children out. That’s the issue that the advisers need to consider, and certainly consumers need to be aware of. Our research tells us that clients still want that absolute certainty. As you move into your later life, the last thing you want to be worried about is your finances, or you want to be less worried about your finances. But what you also require or maybe even demand as you age is the opportunity to change your mind. And that flexibility needs to be core at a price point which is perceived where the value is there. As opposed to it being cheap versus expensive, if there is value in the price being paid for both the advice or the product, we are seeing through our research that this whole decision between annuity and drawdown and combination of hybrid products etc. being brought to the market, that’s really what sits at the consumer’s concern. So as individuals age, the whole ageing process, and dealing with an ageing population for an adviser, needs to be reconsidered. The discussion document issued by our regulator looks and focuses on a whole host of issues, and it looks at the way that individuals change their dealing with finances, change their expectations around their finances and their life. It also looks and addresses the way that their cognitive function could dwindle as you age. Many individuals expect to have a very fruitful last few years as they enter into their retirement and beyond. But unfortunately we see many that have an issue with their cognitive function before a power of attorney would kick in, and their mental capacity starts to come into question. And it’s the bit before the power of attorney kicks in which I think advisers need to be certainly very aware of, and revisit their advice process to ensure that the products that are selected to serve the clients into their later life are fit for purpose, to allow them to enjoy the certainty that they require, but also provide the flexibility that their circumstances might demand. PRESENTER: Well that’s the background to the rules and requirements surrounding a drawdown review, and also how client needs and expectations are changing over time. They were recorded a little bit earlier, and I’m joined now by Jan Holt and Richard Sheppard here in the studio to talk them through in a little bit more detail. Well, Jan, there’s been a lot of change in the annuity and drawdown market, not least on the back of pension freedoms. How is that market starting to pan out now? JAN HOLT: Well I think an important point to make is that the annuity didn’t die, and that had been predicted by many. However, whilst drawdown sales have been higher than annuities since April 2015, annuities have still held their own really well. In fact for the first time since April 2015 in Q4 last year sales of annuities were actually higher than sales of drawdown. PRESENTER: When you sales of annuities, does that include impaired life in those figures? JAN HOLT: Yes it does, so that’s all guaranteed income for life annuities. PRESENTER: And, Richard, how are you seeing the market panning out after this initial burst of enthusiasm after pension freedoms? RICHARD SHEPPARD: Well, exactly, the burst of enthusiasm is probably the key point. As Jan’s highlighted, we saw a massive acceleration of the drawdown sales effectively in the early part of pensions freedom world, but what we’ve seen is very much a dramatic slowdown, and that can be for a host of reasons. It could be the return to people realising that annuities are still a very valid vehicle. But maybe it could be as part of the advice process, or even the non-advice process, the early adopters are experiencing the actual proportion of tax they’ll pay, and the way they’ll pay their tax through say month one taxation, and there’s an awful lot of learning that we’ve seen. So we’ve seen a massive move from annuity to drawdown, and now we’ve seen it almost shift back. But we’ve seen a calming of the market in our opinion. That’s certainly what our observations would be. PRESENTER: And on balance is it a better world to be providing advice in now? I ask because you’ve produced this report recently on the attitudes of those aged 45 and above to pensions, and you’ve called it the Exposed Generation, which doesn’t sound that positive for anyone over the age of 45. RICHARD SHEPPARD: Well using the title of Exposed Generation really highlights the fact that they’re exposed to many more risks. You know, the security and certainty that annuity gives individuals in terms of delivering a guaranteed income stream until their death bed, provides them with that comfort blanket. Exposing them to the issues of drawdown, which is requiring of management, it’s dependent on charges, reviews, investment performance, a whole host of things, can leave certain individuals who are either unprepared or unmanaged into their retirement and later life in an exposed situation. The key is it doesn’t mean that that’s wrong for them to be exposed; it just means that they need an extra element of care and they need some due diligence applied to that exposure and the vehicles they’ve got. And maybe as part of the advice process there’s a point at which they cash out into a guaranteed income stream. The advisers are learning, with guidance from the regulator, how and when to do that. PRESENTER: Well let’s move on to how you manage those risks that freedom brings. Jan Holt, let’s talk through the drawdown review process, how does that change as the client gets older, moves through their 60s and into their 70s? JAN HOLT: Do you know I think one of the important things for advisers to have in mind is that they understand the client as they are now, and not think back about the client who they used to know. Now that might sound a little bit obvious, but as people do age and their ability to deal with emotional risk for example, you know, dealing with volatility in the markets for example may start to wane, which will have a knock-on effect to their attitude to risk. And the trick for the adviser is to spot the point at which things have started to change. PRESENTER: Well that’s the emotional journey that you can go on, but how do your actual needs for cash change, where you want to leave your money change as you go through your 60s and 70s and 80s? JAN HOLT: Well I think that will depend by and large on why the client was using drawdown in the first place, and we spoke earlier about how many of them are looking to hang on to those pension resources and pass them on. One of the key things that could influence the ability to do that are any unexpected expenditure that the client comes up against, so one example of that is maybe a need for care funding. So all of the good planning, all of the best planning in the world actually could be for nothing if the client ends up having to move into residential accommodation, and for quite a long time. That can be quite devastating on any resources that the client has left. So that’s just one example of somebody’s needs changing as they go through retirement and into later life. PRESENTER: So, Richard Sheppard, you probably need to work out which of these are insurance issues for your clients and which are investment issues. RICHARD SHEPPARD: Exactly right, because we can probably look and address the insurance issues, but the investment issues are outside of our control. As good as we all become in this post-RDR world, none of us can control the market. So we need to make sure that we are in regular communication with our clients, reassessing their needs on a regular basis. All of that sounds like good and consistent financial planning process, it’s just maybe we need to rethink as the population ages acknowledging that their needs, their demands change, their expectations also change as well, but if we drill down as to what their expectations are at the outset, at the start of the process, then we can maybe start to build a portfolio around their pensions and non-pensions assets to cover or certainly mitigate some of those risks as we age. Because things do change, and unfortunately there will be people today who suffer an incident which is going to change the rest of their life. And that could have an impact on all of the plans that have been put in place for them. JAN HOLT: Yes, and whilst it’s not necessarily the most cheerful of conversations to have, it’s useful to have those conversations right at the outset of somebody entering into flexi-access drawdown. And then as Richard said you need to make a plan for those, or you can at least manage expectations if the client doesn’t have the resources to ring fence those funds. PRESENTER: Now, Richard, one of the things you were saying in your earlier piece was about this whole issue of cognitive change in clients. What are the practical effects of that? If you’re an adviser what do you need to start thinking about doing with your client and their family? RICHARD SHEPPARD: Part of the education process of an adviser, this journey towards level 4 understanding, towards chartered status level 6, there is a structure, an acceptance that a power of attorney is put in place for many ageing clients. The bit that concerns both myself and the regulator would be around the bit before the power of attorney kicks in. And my guidance to an adviser would be just test how good your relationship is, not necessarily with the client but with the client’s wider family. Because as and when mother or father start to find challenges about their decision making, the children could well get involved, or a trusted friend, a confidante, and does the adviser know that individual well enough? Are they comfortable enough to have conversations about the client that they call their client, and their financial affairs? And is their process robust enough in order to allow that? Because that’s the biggest challenge, making sure that they can give advice in the round. As all of those changes happen, the client might listen and accept and welcome the advice that an adviser is giving them, but they might seek out that second opinion if there is that element of doubt in their brain. PRESENTER: Now one other quick thing before we move on was around this whole issue of how long people are living for, and what inflation can have on the value of their money. I mean no one seems too worried about inflation today, but over the next 10, 15, 20 years it could be a very different story. RICHARD SHEPPARD: Well I would disagree with you, if I may, because as part of the Exposed Generation report that we put together, the research tells us that it is the second biggest concern for respondents. They’re worried about inflation, even though it is, and don’t get offended by this, negligible at the moment. Because they like me remember back in the ‘70s that inflation can rise as well as fall, and they can remember that. And if we return to even a slightly higher inflation situation than we have at the moment, and people don’t die, they live longer, that’s the longevity, it could impact on their savings. PRESENTER: Have you got any figures around how the real buying power of money can be undermined, even by quite low levels of inflation? RICHARD SHEPPARD: Well yes, around 3½% inflation over 20 years devalues the buying power by 50%. So what you’ve got enough to spend a pound on today, in 20 years’ time at 3½% inflation you’ve only got 50p to buy that same item. That’s the reality. And living 20 years when you’re 65 is realistic now. In fact if you’re 85 living 20 years, if you’ve survived to 85 chances are you’ve got a pretty good chance of living to 105. That’s the impact of longevity. JAN HOLT: And that’s the important point. Longevity is an issue not just for people as they go into retirement, but keeping an eye on their likely life expectancy all the way through. So for example somebody at 75 even in average health has got a 50/50 chance that they’re going to make it to aged 91, and a 25% chance of living to 97. So you’re not just up against inflation from the earlier part of retirement, it’s an ongoing issue for people as they get older. RICHARD SHEPPARD: And clients don’t wear a badge saying I’m the one that will survive. You have to treat everybody the same. Some will win, some will lose. JAN HOLT: Yes, and that’s the whole point about longevity risk. It isn’t about average life expectancy; it’s about the chance that actually you might live longer than the average life expectancy, in which case things like inflation, sustainability of income become an issue. Or actually the chance that you don’t live as long as average life expectancy, in which case the need for some good death benefits in your plans are equally as important. PRESENTER: So should you as a rule of thumb assume everyone’s going to live 10 years longer than the average, and that’s the worst case scenario to plan for, how do you marry that? RICHARD SHEPPARD: That’s a plan, and the good thing is is you would have a plan. Again evidence tells us that people dramatically underestimate their life expectancy, dramatically. And you could say five years, you could say, it depends on which research you look at. But yes, I would, in my opinion I think add 10 years at least onto everybody’s expectation. JAN HOLT: Yes, I think you should help the client consider a range of outcomes and not get hung up on the average life expectancy figure that’s been in the latest ONS publication. PRESENTER: All right, well let’s move on from that. We were talking about drawdown reviews. Right at the middle of this is the critical yield. Jan Holt, just how critical is it to work out and why? JAN HOLT: Well critical yield is only one part of the drawdown decision. It’s not the be all and end all for some clients. However it is important because critical yield is giving you the benchmark investment performance that you need to achieve in order to be able to match against the annuity that the client could have bought at the outset. So when they’re making that decision between whether they guarantee income for life, or take a drawdown option, that’s one of the key factors that they have to look at. So that’s critical yield A that will match against the annuity that the client could have had. Critical yield B would actually allow the client or the adviser to select a level of income, and then see the investment performance that they’d need to be able to generate that income on a sustainable basis. So that’s what critical yield is. In terms of the component parts that sit inside a critical yield calculation, primarily you’re looking at an annuity rate, you’re looking at introducing some extra yield that you need to deliver to counteract the effect of mortality drag, and you’re looking at some costs and charges. So the key thing is to make that critical yield figure as accurate and relevant to the client as you possibly can - which means that as the adviser you have to understand what assumptions are being made when that critical yield was calculated. And then you have to decide whether those assumptions actually reflect in any shape or form what the client could actually get as an annuity. PRESENTER: So this is quite a subjective process, even if you put a lot of work into it. JAN HOLT: It doesn’t have to be. It does depend. If you’re just going to take a critical yield that is being offered by a drawdown provider for example in a review pack, then it’s worth exploring what assumptions have been made. And then looking at the difference it would make if you got a fully personalised critical yield for that client. By which I mean you get an individually underwritten annuity quote and you plug those figures into the calculation. So we can look at some examples of the different annuity rates that might actually go into a critical yield figure. So the chart here is showing us a range of annuity rates for clients between the ages of 70 and 80. So if we just talk through what these figures are. The green line is the worst standard annuity rate available at the time we ran the figures. The gold coloured line in the middle is the best standard annuity rate. But then the blue bar is actually showing us a fully underwritten rate for this particular client, who happens to qualify for an enhanced annuity at what we would call a fairly moderate level, which means he’s a type 2 diabetic, takes one tablet a day and drinks 25 units of alcohol a week. So the first and most obvious thing we see here is that there is quite a gap between the worst rate available and the enhanced rate, and that that gap actually widens as the client gets older. So we can see instantly the impact of underwriting her. So the question is which one of these figures is actually going to be plugged into the critical yield calculator? So if we have a look at the next chart we can see the difference it makes based on that range of annuity figures. So what we’ve done here is we’ve taken critical yield calculations at three different ages, so 65, 70 and 75, and in all of those examples we’ve assumed the age of annuitisation to be 10 years forward. So if we pick up on age 75, because what this is showing us is that when you use the fully underwritten annuity rate in the critical yield calculation, there’s actually a 63% difference between the critical yield using the lowest available annuity rate, so critical yield at aged 75 on the worst standard rate would come out at 4.89%, as compared to just over 8% based on the fully underwritten figure. PRESENTER: So the more work you put in the better the result you can get for your client. JAN HOLT: The more accurate the result, which does of course have a bearing on the investment strategies that you would need to choose for that client. If you’re trying to deliver investment performance of under 5%, as compared to delivering performance over 8%, quite a significant difference there. PRESENTER: And, Richard, taking all those statistics and figures, how easy is it to take those and translate them to something that relates to what the client’s expectation is? RICHARD SHEPPARD: Well clients’ expectations of course sit at the core. The client sits at the core of the advice process. Part of our research we asked the question actually as to what an individual deems as reasonable to expect in their post retirement investment return? And the average answer came out 8½% a year, which most advisers will probably be watching this video now with raised eyebrows and a sharp intake of breath. Because you’ve got a human being with an expectation of 8½% but the advice process which Jan has articulated through driving out critical yield has to also consider when you try and put this into practice the client’s attitude to risk, their capacity for loss and the achievement of all of these issues. All of this against a background of an ageing population where the brain is starting potentially to dwindle through cognitive function. You’ve got all of that to consider. The reality of speaking with a client face-to-face, and delivering the financial planning practice becomes a real skill. And that’s where the adviser themselves really does demonstrate their value. Making sure the appropriate cash out time I think is the phrase which is becoming more appropriate, cashing out of an annuity, into an annuity or a guaranteed income vehicle from what I refer to as a naked investment vehicle, providing the underpins of certainty for a client is key and critical. PRESENTER: And what, just very quickly Jan, if people are deferring taking an annuity, age 60 what percentage of people could apply for and be accepted for an enhanced annuity, and how does that change as people get to 70, 80, 90? JAN HOLT: That depends very much on each individual client, but what we do know is that obviously as clients get into their 60s and beyond they’re more likely to develop these conditions like diabetes, like some of the other, high blood pressure and so on. The very common lifestyle factors that will enable people to capture that enhanced annuity rate. But of course it’s important to check that at every advice point with the client. So you need to look at it at aged 60 if they’re just going into flexi access drawdown. Equally you need to revisit that every year, because if something’s changed that could trigger the need for the adviser to start to look at the drawdown exit strategy. And for many clients that won’t be a one and done exercise, it will be something that takes place over a number of years, so almost phasing out of drawdown as and when either the markets are right or the client’s ability to capture that better annuity rate becomes apparent. PRESENTER: So as an adviser should you basically have a tick list of conditions, and every time you see your client, I wouldn’t say every six months but every now and then just go through it again and see if things have changed? JAN HOLT: Yes, and it would be difficult I think on a practical level to go through an entire medical questionnaire with every single client in every review, because the retirement health form, which is the common questionnaire used by annuity providers, runs to 21 pages; however, what you could do is triage your clients. So we’ve developed for example a document with five questions on that allows the adviser to do exactly that. Because they’re yes/no answers, and if the client answers no to all of them, so it’s about their smoking, their drinking, their BMI, whether they take medication and whether they’re having any tests or hospital treatment, a clean sheet on that, i.e. you answer no to everything, means that it’s highly unlikely you’re going to qualify for an enhanced annuity. So from the adviser’s perspective they’ve got their something that sits in their audit trail as evidence that they’ve taken the client’s health and lifestyle into consideration. Of course if the client does answer yes, then that is an indication you probably need to go on and complete the full medical questionnaire. Because if people are thinking that well maybe 75 is the new 65 when it comes to annuitizing, you need to check that your client actually is only 65 in annuity terms. So this concept of what we call equivalent age means that if their health and lifestyle has changed at the point when they’re 65, then actually they could be capturing a 70-year-old’s annuity rate now. So in that scenario there may not be an argument to defer that annuitisation. RICHARD SHEPPARD: There’s one key issue that we need to again just reinforce, and that is not everybody survives. So against this backdrop of consistent review, consistent reassessment of the client, at the back of our thought process as an adviser, and also the product selection, we need to consider the unfortunate. And that is you put somebody into drawdown because it’s the right and appropriate methodology for their retirement function at 63, and unfortunately as they’re driving away from your office having accepted your advice and actioned it, they die in one way shape or form. So the product selection needs to consider three things: the survival, the cashing out and management of their retirement, but also the unfortunate incident when people die. Because in order to work out average life expectancy some people die early, some people die late, and as I mentioned earlier on people don’t wear badges. The product solutions that are available now, such as we offer, can build in death benefits where the investment fund is returned to the client. Well not to the client obviously because they’re deceased, but to the client’s estate in a way. But it also can counter the client’s surviving with a guaranteed income rate and staying invested. So, all of those processes need to again be borne in mind if the client were to either die early or die late. PRESENTER: And I suppose for many people are thinking it’s either annuity or drawdown. The world I guess is probably a little bit more complex and nuanced than this. How are people starting to mix products up rather than being in an either/or camp? RICHARD SHEPPARD: Well we’re seeing an awful lot. Again many advisers will be familiar with this wonderful phrase of third way. We’re probably up to 15 or 20 ways now of delivering a blended type solution, or a hybrid solution. Many of them are being portrayed as new to the market. In my opinion they’ve been around certainly in MetLife’s existence since 2007. So these products have been there with all of the certainty that an annuity can offer through income rates and guaranteed income and through towards death. But also the flexibility of an investment fund which is available to the client should they wish to then cash out to an impaired life annuity, or cash out to other forms. So that type of product has been available. What we’re seeing is is we’re seeing the bringing together of products within various different wrappers. Fantastic that we’re seeing it, but we just need to be careful as an adviser that the component parts actually add up to what the client needs in terms of their objectives and expectations. PRESENTER: How do you guard against all of this complexity, all these bells and whistles just confusing an adviser, and actually under that confusing the end client, it just turns them off? RICHARD SHEPPARD: Yes definitely. I mean Jan and I love this type of arena because it does, it’s fascinating. And as an adviser we need to be very careful. We’re talking to end line consumers who really all a consumer in my opinion wants is to be looked at by their adviser and told that everything is going to be all right. If the detail is required then that needs to be done. There is justification, there is credibility that needs to be built up through the file, but at the end of the day sometimes consumers don’t need to be made aware of all of the issues behind a critical yield, how you define a critical yield, how you assess a client’s attitude to risk and capacity for loss, how you bring into what I call the cycle of doom where you start with a client need of income. Assess their attitude to risk and their capacity for loss, and the income required means that they need to deliver a critical yield of X, but their attitude to risk and capacity for loss means it’s just a square that can’t be squared. So how do you deal with that? And sometimes the client just needs to be told what you’re looking for is unrealistic. Having that confidence as an adviser is something which might be unusual or awkward for some. Many advisers are very good at doing that. But it could be a skill that as part of the communication in this new world that we need to revisit and blow some of the dust off. Because sometimes consumers just need to be kept in the completely informed as to what the outcome is against their expectation. Some of the detail needs to be shared but it doesn’t always need to be understood. JAN HOLT: That said they do need to be, they do need to understand the risks associated with any arrangements that they’re in. And there are lots of different tools out there now that can help advisers articulate and demonstrate those risks to those consumers who aren’t necessarily the most sophisticated of investors. PRESENTER: But when we’re talking, you were talking earlier you mentioned things like mortality drag, is that something you’d need to explain to a client or? JAN HOLT: At some level they need to understand the implications of staying in drawdown and fighting this uphill battle against mortality drag, because at some point in time the adviser might have to have the conversation with the client about the need to take on more risk to counteract the effects of mortality drag. So at some level yes they do need to understand that, and there are various ways and means of explaining it to a client. The alternative of course is that becomes part of the exit strategy. So, because the challenge there is at the time you’re asking the client to take on more investment risk because the critical yield is now at 8 or 9%, then that’s probably coinciding with the point in time where the client’s appetite for risk is actually going in the opposite direction. So whilst it might not necessarily be a technical discussion about mortality drag, as Richard’s just said it might be around the more softer side of things like is attitude to risk changing, and what can we do about that, and having that debate with the client about alternatives to full exposure to investment risk or higher exposure in equities, that might well be pushing them further away from their attitude to risk than they’d be comfortable with. RICHARD SHEPPARD: And the skill of an adviser isn’t necessarily on being able to explain to every client mortality risk. It’s being able to identify out of five of their clients which one needs to understand. Because certain clients will want the comfort of knowing everything, certain clients to revert to my earlier point, just want to know that everything’s all right. PRESENTER: OK. Well we’re almost out of time, so a final thought from each of you. Jan, I’ll come to you first. If you had one message to leave people with around this whole issue of drawdown reviews for advisers, what would that be? JAN HOLT: Well I would say it’s a good time to review the drawdown review process, and to take into account all of the technical points like the critical yield into that process and have a look at the tools out there that can help you make that as robust as it possibly can be. Not just for your own regulatory protection, but clearly to get your clients a better outcome. PRESENTER: So review the review. Richard Sheppard, how about you? RICHARD SHEPPARD: I’m afraid it’s going to be in three forms. The first one is to review the client’s expectations, and make sure you fully and completely understand and appreciate those. The second one would be to, as Jan has identified, make sure that your process is fit for purpose. And the third one is just constantly speak with your client, make sure that you are aware and testing points one and point two. PRESENTER: We have to leave it there. Jan Holt, Richard Sheppard, thank you both very much. And thank you for watching. Do stay with us, there are some learning outcomes coming up in a moment. In order to consider the viewing of this video as structured learning, you must complete the reflective statement to demonstrate what you’ve learned and its relevance to you. By the end of this session you will be able to understand and describe how to create a drawdown review process; how to take account of longevity, mortality and inflation risks; and the importance of an accurate critical yield analysis. Please complete the reflective statement to validate your CPD. And do keep an eye out for other Akademia learning modules on pensions.